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U.S. House of Representatives,
Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises,
Committee on Financial Services,
Washington, DC.

    The subcommittee met, pursuant to call, at 1:35 p.m., in room HC-8, The Capitol, Hon. Richard H. Baker, [chairman of the subcommittee], presiding.

    Present: Chairman Baker; Representatives Ney, Shays, Cox, Bachus, Royce, Lucas of Oklahoma, Shadegg, Weldon, Fossella, Biggert, Miller, Ose, Toomey, Hart, Rogers, Kanjorski, Bentsen, J. Maloney of Connecticut, Hooley, S. Jones of Ohio, Capuano, Sherman, Inslee, Crowley, Israel, and Ross.

    Also Present: Representatives Oxley, Roukema, LaFalce, and C. Maloney of New York.

    Chairman BAKER. I offer a small apology for the environment in which we find ourselves holding this hearing on this most important matter. We, of course, appreciate all of the courtesies extended by all of those interested in the matter, and we certainly will try to facilitate providing information from the hearing to all of the parties, for those who can't simply get in the room. Ranking Member Kanjorski and I have adopted a no-jacket requirement for the proceedings. Feel free to comply at your leisure. I suspect as the day wears on, that will become a better and better idea.
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    Of course the hearing today is an extraordinarily important one, and I am very anxious that we as a subcommittee come to some recommendation for resolution of a problem of potentially significant systemic events to our economy. There is no doubt that we must act, and we must act in a timely way. But we should also act as best we can in the most professional and responsible manner time will permit. It may be very difficult to reach a long-term permanent solution if the remaining tenure of this session is indeed a matter of days. If, however, we have the luxury of time, then I am confident working together with regulators, the industry, stakeholders, consumers and members, we can reach an accord which will make economic sense and sense to the American taxpayer.

    To that end, I merely want to point out one historic event that I think is constructive in these times. Going back to the days of the Reconstruction Finance Corporation under the Roosevelt presidency pursuant to the Great Depression in which in the course of the activities of that organization some $50 billion worth of financial resources were made available to a plethora of business organizations. What I found interesting about it is the manner in which the Texas businessman administered that program at the direction of the President. Fifty billion dollars in the 1930s is an extraordinary program, and at the end of the day, Jessie Jones, the administrator of the program, recouped every cent of taxpayer dollars.

    Now, I know that the discussion of repayment of credit extensions is a very contentious matter, but as I said to some insurance company executives, they have their shareholders, and we have ours. They simply want our shareholders to give up our resources with no expectation at the moment of having their shareholders repay this courtesy.

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    I for one feel that is a very appropriate thing for us to explore and to discuss and not simply because of the urgency of this matter take action that leaves taxpayers with unlimited, incalculable liabilities. However, there is no doubt that the events of this year are extraordinary. Very difficult to reconcile, and we hope never to occur again, but we simply cannot rely on those events not reoccurring, perhaps unfortunately even in the near term. So the subcommittee must act.

    I would refer Members to the Jessie Jones story of the 1930s with the recognition that the elements of that resolution were the basis for the Lockheed assistance in 1971 and the Chrysler Corporation workout in 1979, both of which resulted in taxpayers' resources being repaid and in one case the Government actually taking an equity position in one of the deals and showing a small profit. I think those are very helpful for the subcommittee to consider in the course of this difficult matter.

    With that, I would like to call on the Ranking Member Kanjorski for an opening statement.

    Mr. KANJORSKI. Thank you, Mr. Chairman. Mr. Chairman, I have prepared a full statement, but not to bore everybody in the room, I am going to try and truncate.

    I just want to state my position, and it is very simply this. As a result of the occurrence of September 11th, I believe we must temporarily reinsure the marketplace to safeguard against the cascading financial crisis. In recent weeks, several alternatives to solve the problems were merged from one plan to establish a Government backstop for reinsurance designed to spread the risk across the industry. Another approach using quotas would distribute reinsurance costs for between industry and Government, and other solutions include allowing companies to build taxpayers reserves, limiting liabilities from damages as we presently do for accidents to nuclear reactors and facilitating the issuance of catastrophic bonds.
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    From my perspective, any legislation to assist the insurance industry and our economy in the short term should adhere to four principles. First, to the extent possible, the primary insurers must continue to bear the tangible share of the risk for future attacks through the use of deductibles, premiums or assessments. Equity owners must also carry some share of the risk in order to encourage them to implement appropriate safeguards.

    Second, we must sunset the program. The reinsurance industry is dynamic, and we should not disrupt the development of new products.

    Third, in order to protect taxpayers, we should consider placing caps on the Government's liability and implementing adequate oversight.

    And fourth, everyone from the real estate mogul to the average homeowner should participate in the program.

    As I have said in our last hearing, we must move cautiously and methodically in addressing this problem in order to prevent unintended consequences. Given our forthcoming adjournment, however, we must also move swiftly. Instead of convening additional hearings on this problem, we should quickly assemble a bipartisan, bicameral group to negotiate the solution with experts and industry leaders. Time is of the essence, and I stand ready to work with you, Mr. Chairman, and all other interested parties on these matters in the upcoming days.

    Chairman BAKER. Thank you, Mr. Kanjorski.

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    Chairman Oxley.

    Mr. OXLEY. Thank you, Mr. Chairman, and I will make the full statement part of the record. Without objection.

    Chairman BAKER. Absolutely.

    Mr. OXLEY. Welcome, Mr. Secretary. This is, as you can tell from the other opening statements, a very serious issue we are all aware of. We need to address this. This will be, along with our money laundering bill we passed last night in the House, probably the most important issue we are going to have to face and we need to do it in a timely manner, and I salute the Chairman of the subcommittee and the Ranking Member for their leadership on this issue. We all have to pull in the same direction.

    I think we will find some differences of opinion on the proposal that you will be outlining, along with the industry people, but the purpose of this hearing, as I discussed with Chairman Baker, is to get all of our cards on the table, all of the ideas on the table and then start to whittle away until we create something that we can all live with and that will work.

    Clearly this is not just an insurance issue. This is an issue that will affect our entire economy. A concern all of us have, I think, is that we will get a domino effect on the inability of companies to get insurance, the inability of lenders to lend to those companies, and it would have enormous negative consequences, and I notice you commented on that in your statement. So we are all in this together, and we will work with you and all your folks on this issue, and I yield back.
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    Chairman BAKER. Thank you.

    Ranking Member LaFalce.

    Mr. LAFALCE. Thank you very much, Mr. Chairman. I ask too, unanimous consent to put my full statement in the record.

    Chairman BAKER. Without objection.

    Mr. LAFALCE. Let me give you a couple of thoughts. First of all, I have been through so many situations over the years where we have been cutoff the credit or at least the credit crunch due to severe problems, lenders liability under CERCLA, for example, the banks wouldn't lend to the business if there was the remotest possibility of environmental difficulty for which they could, because of a $5,000 loan be liable for a $5 million cleanup, and I am most fearful of the economic impact to the United States, the damages to the economy, if we have the cessation of terrorism insurance.

    Do I think the problem is real? Unfortunately, I do. I do think it is real, and therefore I think we have to do something.

    Now, what do we do? I wish we had the luxury of careful deliberation. We don't. If we had the luxury of careful deliberation, I think we should come up with some scheme. It might be something similar to the scheme that England has, with a Federal charter and a Federal regulatory supervisory role commensurate with the Federal risk. I think that is going to be difficult to implement. We don't have that much expertise within the Federal Government right now to implement that immediately, and that is one of the reasons I think that representatives from the insurance industry have come up with a single State charter, but the State charter could be with an administerial role for the State, but still, because of the Federal assumption of risk a strong Federal regulatory supervisory role. I think that is a possibility. It is not my preference, but it is something. But even then, I don't know if we have the time to do it or the present expertise in the Federal Government to do it.
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    The third alternative is some stopgap, and I think that is where the Administration is, based upon my conversations with both Sheila and Peter Fisher. That is not my preferred option, but it may be the only viable option now. If that is true, it is either easier to coalesce around one Administration approach than it is one approach after 535 individuals have come to consensus, so I am willing to do it. But not willy nilly either. You know, there has got to be some principles that we follow, and at least we have to make sure that we are going to provide insurance for all Americans and businesses who need it, including a full range of property and casualty coverage. For me—and I don't know if the Administration is there yet—I think that means business interruption insurance, too.

    I want you to address the issue, because I don't think we are adequately covered if we don't have that.

    Second, if the Federal Government is going to put its toe into the water, we have got to make sure we have got all the desirable regulatory safeguards to protect the American taxpayer. We can't, you know, put a toe in without being protected. OK?

    We have to require the industry to share the burden of any system that is ultimately adopted, and I think perhaps requiring even more of a first dollar contribution than presently contemplated by the Administration, that is negotiable, and have the price structure that provides compensation to the Federal Government while offering affordable prices to the ultimate consumer and facilitate the return of the private reinsurance market as soon as is possible if it is ever going to be possible. I look forward to working with you and Sheila.

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    Chairman BAKER. Thank you, Mr. LaFalce.

    I would ask if possible for all of the Members' statements be made a part of the record so we could hear from our first witness. Without objection, so ordered.

    It is a pleasure to welcome you here, Mr. Secretary. Chairman Oxley wanted me to make it very clear, he is not responsible for the meeting arrangements. He would have treated you with greater deference, I am sure, had we the luxury of time.

    Mr. OXLEY. Mr. Ney.

    Mr. NEY. Hey, this is the way our country was formed. Get with it.

    Chairman BAKER. I hope we are as successful. With no further delay, Mr. Secretary, we are honored to have you here today on this most important matter. Thank you, sir.


    Secretary O'NEILL. It is a pleasure to be with you and all the subcommittee Members. And Chairman Oxley, if I may pick up on a point you made——

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    Unidentified SPEAKER. Can you speak up a little bit for those of us that are sitting on the end here? Thank you.

    Secretary O'NEILL. Let me say again, thank you very much for the speedy and I think very valuable action on money laundering. We are determined to do what the President said and wage a successful war on terrorist finance, and money laundering is a part of that issue and drug running and all the other things that we have talked about for a long time. With the added authority you have given and with the President's Executive Order, we are going to make this happen. We are going to shake down these people and their finances and do everything we can to take them out of business and we have had great cooperation around the world, and thank you all for that.

    Now, to the issue of today, I don't know—did all of you—whether you had a chance to look at the prepared statement or not? And Chairman, how would you like for me to proceed? I have a short oral—actually, it is about 10 or 12 minutes—oral statement. If you would like me to begin with that, or I can simply put it in the record and go to questions, whichever you would like.

    Chairman BAKER. Proceed as you wish. Maybe outline the highlights of the plan, and I think this opportunity for Members to engage with you would be terrific.

    Secretary O'NEILL. Great. As I said, I appreciate the opportunity to comment on terrorism risk insurance. We believe that there is a real and present need for Congress to act on this issue now. Market mechanisms to provide terrorism risk insurance coverage have broken down in the wake of September the 11th. Such coverage is now being dropped from property and casualty reinsurance contracts as they come up for renewal, for policies renewing at year-end. If Congress fails to act, reinsurers have signaled their intention to exclude such coverage, meaning that primary insurers may have to drop this coverage or institute dramatic price increases.
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    As a result, after January 1st the vast majority of businesses in this country are at risk for either losing their terrorism risk insurance coverage or paying steep premiums for dramatically curtailed coverage. If businesses cannot obtain terrorism risk insurance, they may be unable to obtain financing or financing may be available only at much higher cost. This would have widespread effect to businesses of all types, which may, for instance, be unable to expand their facilities or build new facilities.

    Our view is the problem is that insurance companies do not take a risk, and it is a misunderstanding of the insurance process to believe that insurance companies take risk. What they do do is knowingly accept and mutualize risk, which is another way of saying they do analysis of the possibility and probability of an undesirable event happening and then they assemble all the people in the society that they can who have the same kind of risk and charge enough premium so that in the event there is an occurrence of an adverse risk, they have the wherewithal to pay off the cost that they have contracted to pay, and at the end of the day what insurance companies do is that mutualizing of risk function, and in order to stay in business they must always have enough combination of premium income and earnings from the premiums that they collect in order to discharge all their obligations and make a market rate of return on the capital that they have employed.

    So I want to say as affirmatively as I can that the Administration is not for ''bailing out'' the insurance industry. What we have proposed is not bail out anybody; it would instead provide for an ongoing mechanism to insure and to provide for the mutualization of risk.

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    Because insurance companies do not know upper bound of terrorism risk exposure, they will protect themselves by charging enormous premiums, dramatically curtailing coverage, or as we have already seen with terrorism risk exclusions, simply refuse to offer the coverage. Whatever avenue they choose, the result is the same: Increased premiums and/or increased risk exposure for businesses that will be passed on to the consumers in the form of higher product prices, transportation costs, energy costs and reduced production. Put another way, any of these choices have the potential to cause severe economic dislocations in the near term, either through higher insurance costs or higher financing costs.

    Since September the 11th, the uncertainty surrounding terrorism risk has disrupted the ability of insurance companies to estimate price and insure risk. Now, as we worked on this subject, we said our objectives are, first, in grappling with this problem, first and foremost, we want to dampen the shock to the economy of dramatic cost increases for insurance or curtailed coverage. We also want to limit Federal intrusion into private economic activity as much as possible, while still achieving the first objective. And we want to rely on the existing State regulatory infrastructure as much as possible.

    After reviewing an array of options—and I truly believe we have looked at the limits of the options that are available—we developed an approach that we believe best accomplishes these objectives. This approach reflects the current evolution of our thinking on this issue, and let me say as clearly as I can, we want to work with you to achieve the best possible solution. When terrorists target symbols of our Nation's political and military power, they are attacking the Nation as a whole. This argues for spreading the cost across all taxpayers. Yet there are also reasons to limit the Federal role. If property owners do not face any liability from potential attacks, they may underinvest in security measures and backup facilities. In addition, the insurance industry has sufficient experience and capacity to price some portion of the risk associated with terrorism and have the infrastructure necessary to assess and process claims. Under the approach we are suggesting, individuals, businesses and other entities would continue to obtain property and casualty insurance from insurance providers as they did before September the 11th. The terms of the terrorism risk coverage would be unchanged and would be the same as that for other risk.
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    Any loss claims resulting from a future terrorist act would be submitted by the policyholders to the insurance company. The insurance company would process the claims, and then submit an invoice to the Government for payment of its share. The Treasury would establish a general process by which insurance companies submit claims. The Treasury would also institute a process for reviewing and auditing claims and for ensuring that the private-public loss sharing arrangement is apportioned among all insurance companies in a consistent manner.

    State insurance regulators also play an important role in monitoring the claims process and ensuring the overall integrity of the insurance system. Through the end of next year, 2002, the Government would absorb 80 percent of the first $20 billion of insured losses resulting from terrorism and 90 percent of insured losses, about $20 billion. Thus, the private sector would pay 20 percent of the first $20 billion in losses and 10 percent of losses above that amount.

    Under this approach, the Federal Government is about absorbing a portion, but only a portion of the first dollar losses, which we believe is important to do in the first year of the program. The key problems faced by insurance companies right now is pricing for terrorism risk. We favor a first dollar loss sharing approach in the first year, because we are concerned about premium increases over the next 12 months. We see this as the best way to mitigate against premium increases, but it may not be the only approach, and, again, we are prepared and happy to work with you to shape an acceptable outcome.

    The role of the Federal Government would recede over time, with the expectation that the private sector would further develop its capacity each year. 2003, we would have the private sector be responsible for 100 percent of the first $10 billion of insured losses, 50 percent of the insured losses between $10 and $20 billion, and 10 percent of the insured losses above $20 billion. The Government would be responsible for the remainder. In 2004, the private sector would be responsible for 100 percent of the first $20 billion of insured losses, 50 percent of insured losses between $20 and $40 billion, and 10 percent of insured losses above $40 billion, and the Government would be responsible for the remainder.
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    To preserve flexibility in an extraordinary attack, combined public-private liability for losses under the program would be capped at $100 billion. It would be left for the Congress to determine payments above $100 billion.

    The Federal Government's involvement under our recommendation would sunset after 3 years. This approach would also provide certain legal procedures to manage and structure litigation arising out of mass tort terrorism incidents. This includes consolidation of claims into a single forum, a prohibition on punitive damages and provisions to ensure that the defendants pay only for noneconomic damages for which they are responsible. It is important to ensure that any liability arising from terrorist attacks results from behavior rather than overzealous litigation. These procedures are important in mitigating losses arising from future terrorist attacks on our Nation and are an absolutely essential component of the program that we have put together.

    Now, Mr. Chairman, for the reasons I have set forth, the Administration believes that the economy is facing a temporary, but critical market problem in the provision of terrorism risk insurance. Leaving this problem unresolved threatens our economic stability.

    We have limits for Government's direct involvement in all those elements of our private insurance system that continue to operate well, and we provide the transition period to allow the private sector to establish market mechanisms to deal with the risk that confronts our Nation.

    In conclusion, I would say one more thing that I suggested this morning to the Senate committee. I honestly don't think we are going to know whether what we fashion together will work, in fact, until it is tested in the market. As well meaning as we may be and as brilliant as we may be, only the market will tell us whether we fashioned a solution that works. And so I suggested this morning to the Senate committee that you all may want to consider giving the Executive Branch some power to adjust the terms of trade in the frame of reference, because the policies that are at risk now are going to get canceled if we don't act at the end of December, and usually policy renewal takes place 45 days before the end of the contract period. So we don't have an awful lot of time to go through an endless process that works itself into next year, and so I think this is a time to think about some extraordinary ways we can make sure that what we do will work in fact, because we can't afford not to have a workable solution that takes care of this problem for the near term.
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    Mr. Chairman, I am happy to answer any questions.

    Chairman BAKER. Thank you, Mr. Secretary.

    Does somebody have a clock so we can keep our 5-minute rule here? OK. Give me a 30-second, you know, hand signal. And as best we can, you will advise me whatever the order for recognition is.

    With that, Mr. Secretary, let me say I very much appreciate the description of the plan as outlined. Certainly I think in prior meetings with the Treasury officials that I have some concerns about elements of the plan, but I want to start with where we agree. I do believe we have to act. I do believe that if we cannot expect the occurrence of anything similar not to bring about significant economic consequences. And if we do not have an event and we approach January 1 and coverage is not made available, construction—the economy just stops. So we want to act very timely. To that end, I also agree we can't know how the market will react to whatever mechanism we do expect, and that for consideration only, perhaps the advisability of a short-term emergency response is to get us through the early months of the year, and I understand the industry reluctance to that. They can't price on something that is not real. But I would just observe that there is very little likelihood that this Congress will reconvene next year and will take this matter up as the highest priority and attempt to act in a very thorough and responsible manner, that even if that is not achievable, then I very much like the idea of discretionary authority and responsibility being given to the Administration to manage this event.

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    So if we don't get it right, there is the ability to act without the necessity of Congressional intervention to protect our economic viability. At the same time, one of the principal things I think that—as you would surmise from my opening statement, is some capacity at the appropriate window for expected repayment. If we go through the scenario of a $100 billion event, given the constraints of the programs now written, the United States taxpayer would ultimately pay for more than two-thirds of the claims paid. I hate to use this, because I overuse this so much, and Mr. Kanjorski doesn't like me using it so much either, but I will do it anyway. It is almost like a GSE chart. If you make money you get to keep it. There needs to be some balancing of equities in this, and with all due respect to the proposal, my initial first reaction to it is it certainly is better than the industry proposal we saw, because we do have some participation by the industry.

    But I want to take you up on the statements that you repeatedly made that we want to work through this, and a mechanism whereby we can visit again, maybe not this week, certainly early next, and go through the essential elements that I think ought to be in any proposal. Administrative concerns, again side-stepping the policy for a moment, if we are going to have to direct providers of insurance laying claim to the United States Treasury for reimbursement of monies paid out as a result of an act of terrorism, the administrative process to do that with 2300 insurance companies each paying multiple claims, unfortunately for those concerned about bureaucracy, you have got to have some questions about how that is going to work. Then we are going to audit and make sure where the money went. I have suggested that our interface with the industry might be at a slightly different level. Wave fast and hard, so I can see. If we engage at the commercial reinsurance level, and it also speaks not only to minimizing the numbers of people with whom you would have to engage, but they are the folks really backstopping in the private market the risk of the direct provider. They also are the ones who set the underwriting stuff. So if you need that extra security, if you need an extra person at the door, if there is some other extraordinary circumstance which is identified in the market as being necessary, let the market dictate those requirements. I would be concerned that the more we become responsible, the more the pressure would be on the Congress to create more regulatory constraints and to begin to set those standards of what is acceptable conduct.
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    And then lastly, by leveling at the commercial reinsurance window, we narrow the scope of review of the eligible participants who have access to the funds. I don't want to have happen with the insurance industry what I would be so bold to say I think may have happened with the airline industry, where there were losses going into the September window that were rolled into the claims paid pursuant to the September event. We need to know who is getting in, that they are solvent, they have the capacity to meet the responsibilities as best any reasonable person could dictate, and if we do that only with the commercial reinsurers, we again are looking at corporations, generally international in scope, generally well priced by the market, and we have a clear view of what their operational condition might be, to limit again the Federal role and bureaucratic responsibility in what will be a very difficult time.

    I can only imagine the explanation by the agent on the street to a claimant about why they hadn't gotten the payment, because the Federal Government hadn't acted in a timely manner.

    Am I out? I am out. I am not even 30 seconds. I am out. But let me just leave it at this. I appreciate your willingness to come here today for this purpose. I appreciate the tone and comments that you have made, and I just as an individual in the room—and I am sure others will speak for themselves—really do want to engage the office to try to come with some resolution.

    Thank you very much.

    Mr. Kanjorski.
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    Mr. KANJORSKI. Mr. Chairman, thank you very much. I have a few questions. Of course, I could name certain principles I would like to go through in terms of when we put this policy together, but first and foremost, on the Administration's proposals, I don't see an incentive for the insurance industry to want to resolve the issue until the absolute down day of 2004. I think if the Government gets involved, and I think we should get involved, there has to be an incentive, either premiums collected or a penalty derived by the Government to encourage the private sector to take up the reinsurance issue. If not, it would seem to me all companies would stand to the bitter end, and I think one of the examples we have always had in flood insurance is there was never an incentive to get out and privatize it. It is going to stay with the Government as long as I guess the leaves turn to brown.

    There is a couple of questions I have. One, I think we should insure actual loss, but not necessarily economic gain loss. You know, we have gone through a tremendous appreciation of assets over the last 7 or 8 years, and I think it would be foolhardy for the taxpayers to bail out investors 100 percent, or a mortgage holder 100 percent if there is reactivation going on in the system to take advantage of moving up the value of the asset to the highest degree or even above 100 percent. We have got to have some stopgap in there to protect it.

    Second, I would like to ask you what portion of this business are we providing the Federal insurance for that is international? How many foreign companies?

    Secretary O'NEILL. None.

    Mr. KANJORSKI. We would not cover any foreign?
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    Secretary O'NEILL. Well, if they were a resident of the U.S., I think they would have all the right that any one of standing has in the U.S., but this is territorial. This is the U.S. .

    Mr. KANJORSKI. Well, U.S. limited policy, but the——

    Mr. KANJORSKI. Right, but we still have primary insurance for foreign companies, and this would apply to all companies across the board. Is that correct? Is there any way we can give a preference to the American insurers?

    Secretary O'NEILL. I don't think you want to distinguish between sources of the capital where somebody's money is better than somebody else's.

    Mr. KANJORSKI. So the RAC national insurance——

    Secretary O'NEILL. There are people we don't let into the country for very good reasons.

    Mr. KANJORSKI. I am just being facetious.

    Mr. LAFALCE. If they are insurers, they have to be licensed in——

    Secretary O'NEILL. Yes.
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    Mr. KANJORSKI. I would rather look at a portion, some graduation of liability. I like the fact that the first dollar the primary insurer has to stand some risk, but I think there should be maybe reverse graduation involved to where we get involved and then, finally, probably some sharing of the premiums. There has got to be something to the taxpayer that takes the risk, simply because I am trying to distinguish in my own mind—and I am not sure that I can anymore—of the occurrence of September 11th, whether that is a terrorist attack or an act of war. Clearly insurers and banks and other investors take the risk of actual war. They are not covered for that. So we could pretty close—I mean, using the President's word, we could make a very strong argument that we are in an undeclared war, and, therefore, we are picking up the next liability for the taxpayer.

    I am willing to do that because I see the economic component, but I think that is justified. But I would just like to see that incentive for the private sector to get involved as early as possible. Some share—maybe the premium should be higher than the private sector so that the private reinsurance industry will see an opportunity to rush in and provide that insurance as soon as possible as opposed to delaying it. We may be interrupting the development of that market by being too generous, and thirdly, real losses as opposed to book losses, I think that is essential.

    Secretary O'NEILL. May I comment?

    Chairman BAKER. Please proceed.

    Secretary O'NEILL. I think from some of the things I have read in the newspapers and some of the comments made, it may be useful to talk a little bit about the concept of insurance. I have tried to do that a little bit in my paper, but I think maybe it is worth emphasizing some points so that we are on the same ground together, and if—you know, simply because of the comments an insurer makes about repayment. Under our scheme, we are not giving—we, the people of the United States, are not giving the insurance companies anything. We are not giving them anything. Now, when you say repayment——
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    Mr. KANJORSKI. We are giving them coverage support.

    Secretary O'NEILL. No, we are not at all. What we are doing is we are saying to the insurance companies that if you go out and write terrorism insurance, that after you reach a level of 20 percent of the $20 billion in the first year, that you don't have any remaining liabilities. Now, you know, maybe what we haven't made clear enough, and I guess we presume is clear, but it is obvious it is not, is that they are not going to write insurance for more than the size of their liability and the size of the premiums that they aggregate together. So they are not going to write us up for $100 billion. We are simply saying we would like for the private sector to play a role, and you are not going to do—we think they won't do it if they have unlimited liability and no reinsurance pool, that there is not going to be any insurance available.

    OK. But if you understand how insurance companies work, what they do is they go out and find people with similar kinds of risk, and they do an assessment of what is the possibility of an untoward event, and then they collect enough premiums and invest the money so that they make income from the invested money, and when there is an untoward event, they pay off. OK? And this would work exactly the same way, but the liability, that is limited, and the reason we started with a fairly low number is because if you think about this now from the point of view of an individual insurance company and, you know, let's take the World Trade Center now and you be the proprietor of an individual insurance company. You would not today go in there and take a risk of having to pay off a $3.2 billion claim unless you are going to get paid something like $3.2 billion, because if it happens, it is a 100 percent event. OK?

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    Chairman BAKER. If I can, the gentleman's time has long since expired, and the Chairman is next. Chairman Oxley.

    Mr. OXLEY. Mr. Secretary, let me take you through some of the criticisms of your proposal. The first one is that this is an obvious industry bailout. You have addressed that to some extent, but indeed we are asking insurers to collect 100 percent of the premiums and then the taxpayers in the first year at least would pick up the bulk of that cost at 80 percent.

    Secretary O'NEILL. That is not really right. You know, it comes across as that portrayal, and I realize now we were not clear enough. The insurance company is not going to write $100 billion worth of face value coverage for $4 billion worth of premiums. What this basically says is we are creating a way for the insurance industry to create a pool that provides a first layer of mutualization of risk with an upper limit of $4 billion in the first year, and the taxpayers are going to, in effect, self-insure the rest. They are not getting paid premiums for $100 billion. They are going to get paid premiums because of the way the process works that gives them enough money to pay off the probable cost of insuring risk. And that is all they are going to get. They are not going to get any gifts, because as competition works, the interaction between the consumers, like where I was before, the head of a company, the interaction between companies, they are saying I want the lowest possible price, and the insurance company, you are saying I want to write the business. It is going to bring this price down to a level that provides at the end a $4 billion pool to pay off the probability of an untoward event, wiping out all of the agreed contractual coverage for the insurance companies. It doesn't do more than that.

    Mr. OXLEY. And in your proposal it is a 3-year package, basically?
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    Secretary O'NEILL. Well, we have said we think as we go along that the insurance industry and the reinsurance industry will likely figure out how to deal with this issue as they were to deal with Hurricane Andrew kinds of issues. They never have before. And so we are saying let us look at a 3-year program with these kinds of characteristics.

     But again I want to say to you what I said before, until we put this in the marketplace we are not going to know whether it really works, and that is why we need to be fast on our feet, because if this doesn't work, we need to figure out a scheme that will actually get the job done by the first of January.

    Mr. OXLEY. Traditionally insurance has been based on obviously risk assessment. Is it fair, for example, let us say that the target is the Empire State Building, or obviously the World Trade Center for a terrorist attack presents a lot more attractive target, if you will, than, say, the Marathon Oil Building in Ohio. And indeed, currently the insurance rates are, for a lot of reasons, different in different parts of the country. Under your provision, and the way you explained it, would the market ultimately then seek that?

    Secretary O'NEILL. Absolutely. If you think about—and I don't want to be quoted as ''O'Neill identified,'' but you all think of places that you know about that are obvious symbolic targets in the United States. They are going to end up in what I would characterize as an assigned risk pool. You all know from your automobile insurance, you know, if you are over 25 and have three children and don't drink and smoke, then you get a preferred rate than if you are 15 years old and you wreck three cars and you get put in an assigned pool. We are going to see the insurance industry go through this probabilistic analysis and the premiums for high value symbolic targets are going to be a lot higher than they are for a suburban home in Maryland. The industry will work out what the appropriate premiums are and again they will do it in a competitive framework of, you know, State Farm says I will cover your house for this, and Hartford says I will give you a little bit less and throw in a blender, and that is how this process is going to work.
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    Because of the scale of what we are facing and the short amount of time that we have to deal with this, I think this is the only reason why we ought to be at the table, because it is right in front of us. There is a high degree of uncertainty, and we need to make sure that we don't go over the cliff January 1st and there is no insurance protection, because the thing that drives us, if you are borrowing money—or even if you are getting money from equity supporters and you don't have insurance to cover casualty loss to your property, you are not going to be able to get intelligent investors to give you money.

    Right? Think about it as an individual investor. Would you give your money to someone who had the risk of losing 100 percent of all of their assets, including all of yours and no insurance coverage? You wouldn't do it.

    Mr. KANJORSKI. Well, they do it all the time in war.

    Secretary O'NEILL. Well, you know, I think you made an excellent point. If you go back and look at what we have done where we have declared wars, basically the American people have been the guarantor of casualty—of war-related events, and if we had a declared war, I think you could make an argument that we ought to move to that position. And I said earlier, one of the things that we did in working this subject, because, you know, for me—and I think for most of you—this is not an issue that lends itself in any way to partisanship. This is how we get it right, and so we looked at the question of maybe the American people should simply say define terrorism and determination of a terrorist act, we are going to use our system of collecting revenues and distributing benefits to people; that is to say, the general fiscal policy of the United States, to pay for acts, for the cost of acts that are determined to be terrorist acts and we will just take the insurance industry out of it.
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    Now, as I have said here, we didn't get there because we think the infrastructure of the insurance industry can bring real value to dealing with the possible future terrorist events that otherwise one would have to consider creating in the Federal Government. That we think would be a disaster, to create a new Federal freestanding agency that is in the insurance business with policy writers and claims adjusters and all the rest of that stuff.

    Chairman BAKER. Now you are scaring me.

    Secretary O'NEILL. We don't want to do that. And so we built in this idea that by creating in effect the controlled and limited risk and then ratcheting it up over time, that we can have the best of all possible worlds and learn as we go along. None of us have been here before.

    Chairman BAKER. If I can, Mr. LaFalce.

    Mr. LAFALCE. Yeah. Thanks very much. I will go quickly. We are ready to let you take the lead. When will you get us the legislative language by? I think there is a disposition to adjourn Congress by Thanksgiving, maybe by Veterans' Day. Some people will say Halloween.

    Ms. BAIR. There is no Administration bill.

    Mr. LAFALCE. Are you preparing it?

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    Ms. BAIR. We are prepared to work with the staff.

    Mr. LAFALCE. Well, if you want to take the lead, you have to take the lead. That means you have to come up with the language quickly.

    Second, what is the necessary effective date? It is one thing to pass it in November, but when must it be effective by?

    Secretary O'NEILL. The sooner the better. As I said to you, most of the notices for renewal come out on the 15th of November, policies that expire on the 31st. So, you know, we need it quick.

    Mr. LAFALCE. OK. Next, if you were to insure, Mr. Secretary, would you advise them to give business interruption insurance or not? I think the answer is yes, you would.

    Secretary O'NEILL. The reason I am hesitating, I used to run a $30 billion company. I did make a decision in some cases to provide business interruption insurance, but out of my 26 businesses, I made different judgments about different parts of my business, depending what the customer relationships were and contractual relationships.

    Mr. LAFALCE. My point is for an awful lot of businesses it is not their physical infrastructure. It is their business itself that is damaged. You know, they have no revenues coming in. They can't pay their bank back. They are going to go belly up with bankruptcy, and they need insurance against that.
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    Secretary O'NEILL. We have not included it. It is a debatable issue, and we ought to talk.

    Mr. LAFALCE. You are not advancing it, but right now you are not saying you are opposed to it?

    Secretary O'NEILL. No.

    Mr. LAFALCE. All right. I think we have to act on it quickly. I am a little afraid that the insurance industry might be taking advantage of us, other people taking advantage of us. You have to be wary of that, too, the same way this economic stimulus bill, think the people are taking advantage of us. I think you would agree with me.

    Secretary O'NEILL. On the latter I agree with you; on the former I don't.

    Mr. LAFALCE. Well, good. In other words, you agree with me on the economic stimulus. It is an open question on insurance, or you don't. Fine.

    Secretary O'NEILL. I think as long as we have competition.

    Mr. LAFALCE. Then I understand you correctly, you agree with me on the economic stimulus bill that we are being taken advantage of.

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    Mr. KANJORSKI. You are going to be quoted on the floor.

    Secretary O'NEILL. I don't want to get in trouble.

    Mr. LAFALCE. You did say we were being taken advantage of.

    Secretary O'NEILL. I didn't say by who.

    Mr. LAFALCE. This money——

    Chairman BAKER. Is the gentleman out of time?

    Mr. LAFALCE. I have been interrupted. I want my time. We passed the money laundering bill today in the House. OK, fine. It is up to you to implement it strongly, aggressively. It is a great law. It can be meaningless unless you implement it strongly.

    Secretary O'NEILL. Not to worry.

    Mr. LAFALCE. OK, good. Now, I am a little concerned about your theological opposition to the concept of a Federal charter. You know, my God, we talk about the global economy and the need for harmonization of our banking laws, our bankruptcy laws, our money laundering laws, and so forth. But with respect to the insurance industry, which was one of the largest industries in the world, my God, we can't have the United States have a law on that. We have got to defer it to the States. This is the 21st century, Mr. Secretary, and let us not be afraid to step our toe into the 21st century with respect to insurance laws. Now, I am not saying we ought to do it with respect to terrorism insurance, because we only have a few weeks, and I don't know that we could get there, but don't be afraid to put your toe in. It is necessary.
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    Chairman BAKER. Thank you, Mr. LaFalce. By my list, I have Mr. Royce next. Is he here, Mr. Royce?

    Mr. Bachus.

    Mr. BACHUS. Thank you. Secretary O'Neill, I commend you for coming forward. I am as serious as you about what you are proposing. The first is that to me this is not a backstop. We have got the most recent proposal. Why is there not a layer of industry exposure any time there is a claim?

    UNIDENTIFIED SPEAKER. Could you both speak a little louder, please?

    Secretary O'NEILL. The reserves that are currently held by insurance companies are held because it is their best assessment, backed up by the securities laws about how much money they need to put away in order to be worthy, creditworthy by the judgment of the State insurance commissioner, that when they have events they can pay off their customers. And so the reserves——

    Mr. BACHUS. Adequate reserves.

    Secretary O'NEILL. I am saying they don't have extra reserves. They have reserves to take care of the business they have already written.

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    Mr. BACHUS. You are saying they don't have adequate reserves?

    Secretary O'NEILL. No.

    Mr. BACHUS. So, that is why you came—no. I am just—that is why——

    Secretary O'NEILL. Well, you know, it begins with a very basic understanding of how business works.

    Mr. BACHUS. Yeah. I know how insurance works.

    Secretary O'NEILL. And how insurance companies work. They go out and they sell policies—.

    Mr. BACHUS. Now, you are lecturing us about——

    Secretary O'NEILL. I don't mean to be lecturing.

    Mr. BACHUS. You have looked at a backstop proposal and you have rejected that. You think first dollar coverage is necessary, right?

    Secretary O'NEILL. I think if we said to the insurance companies, for example, right now that we want you to write terrorist risk insurance and you all are responsible for the first $50 billion.
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    Mr. BACHUS. The second question is this, there is no catastrophic loss of over $100 million, which is what I think is the worst-case scenario, which I would think that you would address that. I think that is what the reinsurance people are concerned most about. There is absolutely nothing above $100 billion. Did you all consider that?

    Secretary O'NEILL. Well, what we basically said is when you get to $100 billion, we the people of the United States will own it all.

    Mr. BACHUS. You think so?

    Secretary O'NEILL. Absolutely. Who else is going to put up the money? I don't know. There is no other mechanism in the world except the good faith and credit of the people of the United States that is going to be good for anything over $100 billion.

    Mr. BACHUS. All right, let me think. Third, I don't think the insurance companies can prepare for phase-out of the Treasury program, because there is no tax incentive. There is no reserves against terrorist risk or other means. Why don't we start planning for the future? This 3-year plan basically acts as if the world is going to last another 3 years. What we ought to be doing is planning for the future and addressing this problem long term.

    Secretary O'NEILL. A couple of points. I don't think we know enough to craft a plan that anybody can say this is the right thing and this is what we ought to do. You know, I haven't found anybody anywhere who thinks they completely understand how we can fashion a perfect solution to this problem and work.
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    Mr. BACHUS. Let me ask you this. As I see it, it fails to spread the risk of terrorist loss throughout the commercial insurance industries, does not provide the market stability necessary to encourage companies to cover terrorist risk. There is no requirement that they cover risk to participate. They could cherry pick. How do you respond?

    Secretary O'NEILL. You know, let me revert to being a businessman. If I were where I was a year ago and I were faced with this situation—and fortunately I was with a company that was so good—but for most businesses they have got to pay a lot of attention to their bankers and to their equity holders and what their equity holders and bank holders will say to them—if there isn't something done like this by January 1st, we are taking our money away from you. And so what is going to happen is businesses are going to be driven to the insurance company to get terrorism coverage, and the price that is going to be charged is going to be related to the risk that an insurance company sees——

    Mr. BACHUS. I understand all that. You know, the final thing, and let me just make this comment. You are not covering life insurance or health insurance?

    Secretary O'NEILL. No.

    Mr. BACHUS. This is basically commercial policyholders.

    Secretary O'NEILL. Yes.

    Mr. BACHUS. So when you say that you are underwriting the taxpayers, in effect you don't really mean the taxpayers; you mean those that are commercial?
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    Secretary O'NEILL. We are not underwriting them at all. They are going to be out there——

    Mr. BACHUS. You said we were——

    Secretary O'NEILL. They are either going to have to self-insure, be forced into the hands of the insurance companies who will write the risk insurance.

    Mr. BACHUS. But, if those people were backing up, not exactly the taxpayers, but the policyholders as opposed to taxpayers——

    Secretary O'NEILL. We are working a way to try to reduce the economic shock that is related to either no coverage or very, very high premiums as many companies wouldn't be able to afford, and some would therefore not have access to financial markets because nobody would give them any money.

    Chairman BAKER. The gentleman's time has expired.

    Mr. BACHUS. I am just concerned about people's life insurance policies.

    Chairman BAKER. Mr. Inslee, are you here?

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    Mr. INSLEE. Thank you, Mr. Secretary, for coming. I am going to take issue with what I think I heard you say, that this is not a benefit to the industry as a whole. I think I heard you say that or something to that effect.

    Secretary O'NEILL. That is exactly right.

    Mr. INSLEE. And I have got to take issue with that, because it seems to me that if we do this, we are telling the industry that you can go out to prospective customers and tell them that if you buy my policy, you will also have in effect access to, you know, $90 billion plus of Federal money if things go south, and vis-a-vis other uses of that customer's money to protect themselves against risk, either by risk reduction work or other investments or the like. This, quote, distorts the market by helping the insurance industry vis-a-vis other expenditures that that investor could make.

    Now, tell me where I am missing something in that analysis. This does benefit the city, because it makes their product more attractive vis-a-vis, say, risk loss investments.

    Secretary O'NEILL. Well, think about the problem as a disaggregated problem. We here in Washington tend to talk about the insurance industry like it is one big monolithic thing. This is all going to be done one transaction at a time. So if you have a corner grocery store, you know, you are not thinking about, oh, the Government is going to provide $16 billion worth of additional coverage. Your issue with your insurance agent is how much the premium is to insure you against complete catastrophic loss in a terrorist incident. And when he tells you that the premium is more than the value of your business, you are going to say, I am going to get on the phone and start calling through the insurance list in the yellow pages and you are going to get people in there swarming around, nickling, diming, trying to figure out how they can reduce your premium so they can write your business. That is the way competition works. That is the way insurance works, and so, you know, all this lofty stuff about $20 billion and $80 billion, it is just an aggregation of millions of individual transactions.
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    So, you know, nobody is going to get done a favor here. Competition, given some time, is going to grind these rates down to an assessment of the probabilistic cost of a terrorist event.

    Mr. INSLEE. Yeah, I agree with you as this is not going to benefit one insurance carrier vis-a-vis another insurance carrier. I accept your point in this regard, but it does benefit the whole industry, vis-a-vis other investment or other expenses by the insured. For instance, if I got a thousand dollars, whether I buy a bomb screening detection device to keep bombs out of my business or whether I put it in insurance premium, this lowers the price of the premium vis-a-vis that other investment.

    Secretary O'NEILL. But the insurance company will help you make that decision.

    Mr. INSLEE. I understand, but the investor, the customer makes that decision, and this is a clear benefit to the industry, because it makes their investment more valuable in relationship.

    Secretary O'NEILL. No. If there is a thousand dollar value associated with a detection device, the insurance company will either charge you the thousand dollars you didn't invest or you will put the money into the detection device.

    Mr. INSLEE. Well, I see we are at loggerheads on that issue. Let me try another one.
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    If you did accept the proposition, if you did, that this was of some benefit to the insurance industry and that the taxpayer ought to have some upside potential in this investment, how would you structure it? If you did want to do something like that, to, in effect, whether it is an equity or it is some benefit to the general fund, how would you structure the other experiences?

    Secretary O'NEILL. Well, I know this is very difficult and I don't mean to sound like lecturing, but let me tell you with 25 years worth of experience running big companies and knowing a lot about this stuff, the way competition works, you know, you can find aberrations, but the insurance industry over time has to earn the cost of capital, and the competition is tough enough that it is very difficult to earn the cost of capital. There are a lot of companies out there, including in the insurance industry, are not even close to earning the cost of capital. So if you want the general taxpayer to get something out of what you think is a benefit, then you are going to have to give the insurance industry enough room so that they can make additional net profit so they can pay you—you, the Congress—something, because competition is going to grind them down to the necessary rate of return on the capital that they employ. They are not going to make economic rent out of this proposal. Competition doesn't create economic rent.

    Mr. INSLEE. My time has expired. I remain unconvinced, but I appreciate the brilliance.

    Chairman BAKER. Mrs. Biggert.

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    Mrs. BIGGERT. Mr. Secretary, as the market is sorting itself out, there are certain areas that are thought of as high risk. One of those would be, let us say, public schools or maybe municipalities or amusement parks. Does your proposal cover those?

    Secretary O'NEILL. We are assuming as to the current practice, it would continue. The Federal Government, basically we are a self-insurer. We do not insure anything. We by habit, if not by explicit decision, have decided to use the future cash flow from our taxes to pay for these kind of events.

    Local government has made different kinds of decisions. Some of them buy insurance. Some of them actually budget for a rainy day fund. We just basically assume that public bodies will continue to do whatever they are doing. We have not made a special provision or assumption about a change in policy direction.

    Mrs. BIGGERT. I think a lot of those local governments are self-insured now. Whether they can afford that risk, if you take those high risks out of those, will we still have problems?

    Secretary O'NEILL. I think so. I think we can find lots of examples like the World Trade Towers where catastrophic loss would be multi-billion dollars. Again, I don't want to tell you any names, but I see the threat list every day. A lot of those places are on the threat list.

    Mrs. BIGGERT. If they are not self-insured, we are right back where we started.
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    Secretary O'NEILL. I am not talking about public, I am talking about private buildings like the World Trade Towers. There are a substantial number of places in this country that have multi-billion dollar replacement costs. I think Mr. Kanjorski made the point about historical value. We should have no conversations like that, because the difference between historical and replacement value in some places is significant, and I don't think you would like to be stuck with just the historical value protection.

    Mrs. BIGGERT. So, if there is high risk and no coverage, is there a provision to require it, or is it just commercial insurance?

    Secretary O'NEILL. We are working on the private sector side. I had a role in Pittsburgh in Allegheny County when I was there, and given what has happened, I probably would be advising the mayor that we have to take a look at whether we can buy some terrorism coverage for bridges.

    Mrs. BIGGERT. Utilities?

    Secretary O'NEILL. Public property. People must be rethinking those things on the State and local level, but we have not designed a new kind of Federal intervention or coverage.

    Mrs. BIGGERT. Do you think that would be a possibility?

    Secretary O'NEILL. I am not sure that we need to do that. I think the market will sort those pieces out without our intervention.
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    Mrs. BIGGERT. Thank you.

    Chairman BAKER. Mr. Capuano.

    Mr. CAPUANO. Mr. Chairman, thank you.

    Mr. Secretary, this is a thoughtful approach toward a difficult issue. I love the fact that you said no one really knows how to deal with this. I appreciate that.

    For the record, I would also like to get your answer relative to if this does not work, I assume you would have no objection to revisiting this next year or 2 or 3 years from now?

    Secretary O'NEILL. As I said earlier, you all may want to consider writing a very unusual provision in whatever you may do, and give the Executive Branch the ability to modify terms and conditions on a very short turnaround basis, because if what you all write gets done, it will be the 10th or 15th of November. If it does not work, we need to make the changes right away.

    Mr. CAPUANO. I am glad to hear that. One of my concerns is as you submit this, and I know it would be very difficult, but I would like to see some pricing estimates. The reason I ask this is because my concern is that terrorism is clearly a societal problem. Insurance is, in theory, in the greatest philosophical theory, all of us chipping in a few dollars so that nobody in particular takes a hit. In the private market system, that gets a little muddled. That is fine.
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    In this particular case when the Government gets out entirely in a couple of years, and let us assume that we do not change it between now and then, my concern is if there is a market impact of the cost of that insurance, that market impact will negatively impact downtown areas in general. That is a general statement.

    The reason I say that is because, let us be serious, the best terrorist targets are downtown. In Boston, it would be the Hancock Tower, the Prudential Tower. That is not a secret. We all know that. It is unlikely that terrorists are going to target a one-story office complex along Route 128 in Massachusetts.

    What kind of impact on the market of leasing, because most of our buildings in Boston are owned by real estate investment trusts? They are not owned by the Alcoas of the world. They are owned by real estate investment trusts that own the buildings. They are the ones that have to buy the insurance, not the companies in the building. The companies in the building will be paying it through lease agreements. You pay a premium for being downtown, and you make a decision, and so forth, and so forth, how much more of an impact is that going to have.

    That is very important, because it doubles the cost of downtown space. You are clearly having an impact on a different market that is unintentional. Again, I don't know enough about pricing insurance to know whether or not this is real or not, but I would like to see something on it.

    Secretary O'NEILL. I think your question is an excellent one. It is useful to return to the principles of insurance. Over time the way premiums are determined is on the basis of experience. If you are an insurance company and you are covering 10 million automobiles and they have crashes at a certain rate, that determines what the premiums are in order to stay afloat and pay the claims and earn your cost of capital.
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    What we all ought to pray for is we never have another experience, and that means there will be no economic cost. There will be premiums for awhile, but the longer we can go without another experience, the lower the premiums can be because there is no cost. God forbid we have experience so we can begin to create premiums on the basis of terrible events happening on a regular basis.

    So I think again, we do not know. There are so many things associated with these events that are just new thoughts that we never had to think about before. This is a broader question even than the question of insurance. If we are going to have to continue to, for example, have a separate facility to open mail because of the anthrax scare, it creates all cost and no value to our society.

    Those kind of deadweights on our society are like the deadweight of having to have insurance coverage that hopefully we never really need to use. We do not know the answer to your question.

    Mr. CAPUANO. I respect that. I think it needs to be thought about, not the least of which are the indirect items such as downtown parking facilities.

    We just had a thousand pounds of fertilizer stolen in Massachusetts. We do not know what is going to happen to it, if it is going to be used by somebody that wants to do something horrendous, they are going to go to a downtown parking structure under a building. That means all the parking structures are gone, and that increases rents.

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    I am a little concerned about the free market having a completely terrible negative impact on the cost of rental property, particularly in downtown markets where people can least afford to have people move out of.

    Chairman BAKER. The gentleman's time has expired.

    Mr. Shays.

    Mr. SHAYS. Mr. Secretary, I would have thought, unless I am not reading your proposal right, that you would want premiums to go up so you start to build a reserve, and that cost could be passed on, but you want a reasonable increase, something that is not outrageous. I was thinking that the cost of premiums would go up, and you would buildup a special reserve, and that over time this reserve would become so large that the liability disappears; that is, if there are no further terrorist activities. My reading is that you really do not buildup long-term reserves.

    Secretary O'NEILL. I don't believe it is desirable for the Federal Government to create an insurance system. I think we have a way in our country of spreading the cost of things that impact society, and it is through a combination of our tax system and our spending system, and it ends up with a distribution effect on the general population.

    I think for the part of the terrorism cost that we are going to accept, unless somebody has a better idea, the interaction of all those things that we do is perfectly fine with me, and we have a basis for spreading the cost for that part that we are going to put on the American people, for the insurance companies. What they will do, they will set premiums that they believe will give them the wherewithal to service terrorist events and earn a 12 or 15 percent return on their capital.
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    Mr. SHAYS. Are you saying they will build the reserve?

    Secretary O'NEILL. They have reserves now against business that they have already written. If they add new business, they will add new reserves. Their premiums will include enough earnings to building up a reserve so if an untoward event happens, they have the money to pay it off.

    Mr. SHAYS. My understanding is that you do the back end and not the front end. The Government says catastrophic, you are the first payer. Yet you are not doing it that way.

    Secretary O'NEILL. I tell you why. It is a very important question of how much the traffic can bear under uncertain conditions and a lack of experience.

    Think about this as an individual business person. You can afford to pay a certain level of insurance costs. Let us say you have been paying a certain level of insurance cost, and now this event comes along and your insurance company says in order to give you terrorist coverage which you need in order to get financing from your bank, I am going to raise your premiums on $1 million a year to $10 million a year. As a business person, if you are go to stay in business, you do not have a whole lot of choice.

    The way we have crafted our proposal is in a way that we think will permit the premiums to be written on each of those business people and not put them out of business.

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    Mr. SHAYS. Do you believe premiums are going to go up significantly?

    Secretary O'NEILL. Premiums will go up.

    Mr. SHAYS. Even if we back them? Significantly?

    Secretary O'NEILL. Yes. Premiums are going to go up, although it depends what you mean by ''significant.'' if you want to make the insurance company just paper processors and guarantee them a 25 or 30 percent rate of return on their capital, they would be happy to take that.

    This is an attempt to get the administrative structure and the value part of the insurance in front of us before the loss.

    Mr. SHAYS. Thank you.

    Chairman BAKER. Mr. Crowley.

    Mr. Bentsen.

    Mr. BENTSEN. Thank you, Mr. Chairman.

    Mr. Secretary, first of all, I concur with the Chairman. I think we would be better off, and I appreciate what you have done and what you have looked at. I don't completely agree with your proposal. None of us know what the perfect proposal is. I think we would be better off having a little shorter sunset, and I would also be a little reticent of extending too much flexibility to the Executive Branch, with all due respect, because at the end of the day, whether our name is on the bond or not, the Congress underwrites, if not fiduciary responsibility, the political responsibility for the taxpayer's liability.
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    I hope you all would take that into consideration, whether we try and do something that just gets us over the hump, and I realize that Congress is not always good about meeting its own deadlines, but we are going to have to focus on this.

    Second of all, I am curious of how you determine your shared loss schedule? How did you decide the ratios that you set in 2002, 2003, and 2004?

    Third, I am not convinced that you have made the case that from a cost-benefit standpoint to the taxpayers, that having a shared loss program with the first dollar coverage on the part of the taxpayers is all that much better on a dollar-per-dollar basis, or even on a market basis quite frankly, than a pooled model similar to deposit insurance.

    I am curious whether or not the fear there, and it is not necessarily a cost-benefit analysis issue, it is a concern of the creation of another bureaucracy, and I am not sure that we can look at the deposit insurance and say that is such a bad system.

    Finally, I would think the way your proposal is structured, and it might be true with pooled structure, is how we score it for budget purposes. I would think that under your proposal we might have to score it dollar for dollar and at some point we are going to have to keep an accounting of the money spent and back into what our long-term solution is.

    Secretary O'NEILL. The last issue is that it would be scored like the money that is now spent for disaster assistance.

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    The pooling idea has some complications in terms of, if you are going to have a pool, yes, it suggests you are going to write policies. If you are going to write policies, somebody in the Federal Government is going to decide what the premium schedule is. And then we are going to charge premiums to people and money will come in, and what will we do with it. If we do with it what we do with almost all of the other money, we invest it in Government bonds where we do not really do anything. We have this paper game.

    Mr. BENTSEN. And I grant you that, in your testimony you bring that up. But even in the shared loss, we are going to have to go through some underwriting analysis.

    Secretary O'NEILL. We are going to write checks.

    Mr. BENTSEN. My question, Mr. Secretary, from the taxpayers' standpoint, have you all determined where the taxpayer is really better off?

    Secretary O'NEILL. I think the taxpayer is better off not having the fiction of a pool and all of the appearance of being in the insurance business when we really do not want to be in the insurance business.

    If you think about setting up a pool, the implication of that is basically that we are going to withdraw capital from society on no particular basis and we are going to hold it aside. That is an added cost to society, that we take capital and in effect neutralize it.

    Mr. BENTSEN. In fairness, Mr. Secretary, if we incur a liability, we are taking capital from society.
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    Secretary O'NEILL. But we take it when we need it and not in anticipation.

    Mr. BENTSEN. If your staff can look at those issues. I agree that we could not do a pooled issue right away. I don't know that we can do any of this right away other than get us over the December hump. If you can get back to me on the question of how you determine your shared loss schedule, what the analysis was, I would appreciate that.

    Chairman BAKER. Thank you, Mr. Bentsen.

    Mr. Ney.

    Mr. NEY. Mr. Chairman, I want to focus on the issue on a broader, generic basis concerning McCarren-Ferguson and our current system and how we regulate insurance. Do you have any idea how the proposal would affect how we regulate insurance with respect to McCarren-Ferguson.

    Secretary O'NEILL. Perhaps Ms. Bair could address that.

    Ms. BAIR. We would want to rely on the current regulatory structure. I think there are a couple of scenarios and issues.

    Mr. NEY. My second question, the plan hopefully addresses the underlying problem of the pricing and various taxes. In other words, if we had an attack 6 years from now, would we be right back to where we started? Is there any consideration about what the tax incentive side of this does for businesses?
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    Secretary O'NEILL. Is your question how you would entertain the needs of tax incentives, and who would they go to?

    Mr. NEY. Without changing our tax laws on the insurance side reserves for terrorism, has that been discussed?

    Secretary O'NEILL. Yes, we have discussed it. It has a certain amount of appeal, because it sounds like we are inducing insurance companies to do the right thing. We are lowering the cost of capital for insurance companies. I don't know why we would want to do that.

    Mr. NEY. Assuming we want to phaseout the Government backstop, if that is an issue?

    Secretary O'NEILL. We are assuming as there is more experience, the insurance companies will figure out a way to neutralize the risk of terrorist attacks in the way that they have done for hurricanes and tornadoes. There have been accusations that there is somehow an interest in bailing out the insurance companies or helping the insurance companies. A tax incentive would lower the cost of capital for insurance companies, which would be a prima facia case for a bailout for the insurance industry.

    Mr. NEY. I just wondered when we talk about incentives, to eventually phaseout the Government's portion.

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    Secretary O'NEILL. We are saying that we will back out, and the industry will fill the hole.

    Mr. NEY. I just wonder in 6 years, where are we at? I am not saying that I would have an idea to have a proposal that tax incentives are the way to go, I am just saying that the Government is going to be removing the backstop. Are there other incentives?

    Secretary O'NEILL. I don't believe so.

    Mr. NEY. Thank you.

    Chairman BAKER. I am advised that the Secretary has a need to depart. If I could make this request of Ms. Bair in your absence to continue. We are most appreciative of your generous time. We do thank you, Mr. Secretary.

    If I might suggest to the Members, we appreciate Ms. Bair's willingness to stay. We would ask that Mr. Hubbard come forward.


    Mr. HUBBARD. Thank you, Mr. Chairman.

    I know that Secretary O'Neill has said a lot about the proposal, so I do not want to go into a great detail, but I want to spend a few minutes with your permission, Mr. Chairman, to talk a little bit about the economic rationale and why we proposed what we did, because I picked up a little of that in the discussion, the questions that you were asking the Secretary.
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    As an economist, the way that I think about the pure economic events of September 11, in addition to the terrible human tragedy, is that in one shot it gave a very powerful supply shock to the economy and a demand shock.

    The supply shock is that it raised the cost of almost everything that we do. The first thing that we looked at with the Congress is commercial aviation. We are talking about insurance costs today, but the transacting cost of doing business went up a lot. That ultimately is going to show up in lower output and all the bad things we are worried about.

    The second issue that does not concern us today is what is the effect on household and business confidence. I think it is important at the outset to reiterate something that Paul said, this is not about the insurance industry.

    The purpose of your holding these hearings, which I think is very helpful, is to think about the property and casualty insurance market and the cost of insurance. There is no reason to suspect that this industry is not competitive, so that the issue here is about costs of insurance and not about the industry.

    One way of thinking about the consequences of not acting or not acting in a timely way is to ask what we might lose. We have already been through the aviation issues and insurance. Here the problem is much more widespread. There are at least three ways of thinking about this. One, think about the new projects. I am trying to build a new skyscraper or general commercial real estate property. My ability to do that depends on the availability of insurance and its cost. Second, and more important, is existing assets. My ability to sell a building I own, a power plant, any facility, depends on the availability and cost of insurance. Those costs are capitalized into the value of that asset.
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    If one thinks about the size of potential costs here, the P&C premia are about 3 percent of domestic income, about $155 billion a year.

    The Administration was concerned about some principles, and I want to go over those. I picked up the flavor of some of the questions to the Secretary.

    In my own ordering, since I was not here for his remarks, I don't know if it is his ordering. One is intervention should encourage, not discourage, the private industry's ability to expand capacity. That is what this is all about. That is principle number one.

    The second principle is that any intervention should be explicitly temporary. We are in the view in the Administration, and I gather many of you are from the questions that I heard, that the industry is capable of stepping up to the plate for a very large share of this and is capable of learning how to price. We have seen this in other areas. We will come back to that. We need to make sure that we have a receding Government intervention.

    Third, we need to give the private sector incentives to limit losses should terrorist events occur, which means less than full cost takeover by the Federal Government.

    A fourth that I will come to at the end is that we need to reduce one source of uncertainty that we really can deal with, which is uncertainty about liabilities that arise from litigation surrounding terrorist events.

    Again, I would underscore that none of these principles has anything to do with a bailout of the insurance industry. In today's Wall Street Journal on the editorial page, an editorial that I otherwise liked, I did not like the beginning because there was an indication of ''eating cabbage.'' There was an indication, coming to the table like we are today, that was ''eating cabbage'' in the editor of the Wall Street Journal's judgment. They talked again about bailing out the insurance industry, and that is not what we are talking about.
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    We want to work with you on the specifics. This is an outline of our ideas. We think that our approach is consistent with the principles from the economics of the problem.

    First, we think that it encourages private sector capacity building and respects the industry's ability to price, market and service products. I am quite suspicious of alternatives that involve direct Government setting of premiums. I don't think that is something that Government officials, with all due respect to my Treasury colleagues, want to be doing.

    Also in that respect I think there are plenty of people who say that the insurance industry cannot learn to do this. As somebody who in my academic life has worked in insurance a long time, I can remember 10 or 15 years ago naysayers saying we will never figure out how to really do disaster insurance. We will never figure out how to get beyond basic insurance and reinsurance, and experience has proven that wrong. I realize that this is a different set of risks, but I have every faith in the industry as being better able to figure out the way to go.

    The second piece of what the Administration wants to do that I think is important is addressing the issue of capacity. I know that came up in some of the questions that the Secretary got. The big issue here is back end capacity. Several Members asked that question. I want to come back to that. That is the key insurance question that the Government ought to be at the table for.

    The third is the fact that the industry is sharing in losses, and indeed in our proposal sharing a greater burden over time up to a cap, and provides, frankly speaking, a profit motive to learn the price. Somebody asked why we had this particular model, I believe it was Mr. Bentsen. The exact numbers one can quibble with. The idea was to give slivers of risk that the private sector would have an incentive to go out and learn. If we take 100 percent of that for some short period of time, we do not give that incentive. That was our economic rationale for doing that.
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    A final point I would make with regard to these principles is that the potential losses that we are looking at in this event, hopefully not in any future events, certainly in this event, depend not only on the security environment, which is something that we are coming to grips with and has a lot of uncertainty, but also in the legal setting.

    The physical costs of Hurricane Andrew at the beginning of 1992 were pegged at $6 billion. They grew over time to more than $20 billion, not because the physical damage was any bigger that it was in 1992, but because of the cost in litigation.

    In order for the private market to do what we want it to do, which is to take over the lion's share of this, we believe and put in the approach that I believe the Secretary outlined for you, a set of legal procedure issues that we felt would facilitate greater private market participation. Those were consolidating claims in a single Federal jurisdiction. That is the sign to promote consistency and avoid redundancy, limit some punitive damages other than obviously for actual perpetrators and abettors, and proportional liability for noneconomic harms.

    This is not an attempt to marry tort reform agendas with insurance agendas. We want the private market to come in and work here. In addition to the uncertainty we are facing about terrorism itself, we have to be able to address uncertainty issues in the litigation area.

    Let me say a little bit about roads not taken. Why not the monopoly pool? There I think a couple of reasons. One, we were very worried about monopoly power. To be frank, that just means higher premiums for businesses and ultimately consumers. We did not think that was wise. It also had the flavor of a very long-term Government presence, which is not something we wanted to suggest to you.
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    Somebody asked about charging premiums, why are we not charging premiums for taxpayers being on the hook. We decided on this sliding scale sharing mechanism as an alternative, because we did not want the Government in the business of setting arbitrary premiums. We will learn more about pricing only as the private sector figures this out, not us in Government.

    Questions came up about health, life and business interruption. Let me take those up. The health issues are issues that should be discussed, but not in our view in the context of the P&C legislation. Likewise on life.

    Business interruption is, just to be really frank with you as to why we did not put this in, is subject to very, in econspeak, moral hazard problems. For small businesses, the FEMA and the SBA emergency disaster programs do provide some stepping in on business insurance. We, of course, obviously are willing to work with you on what is in and out. In terms of exposure for the taxpayer, as an economist I would offer you advice: You do not want to put health, life and business interruptions in.

    The other road not taken was full Government socialization. There again we felt the industry would not have any incentive to learn how to price, and the exit from that we viewed at least as being pretty dicey. That is a quick tour. I am sure that the Secretary told you all about our wonderful proposal.

    Chairman BAKER. Thank you.

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    We are going to pick up in the line of questioning from the Members who indicated an interest in asking questions of the Secretary. Next is Mrs. Hooley.

    Mr. Israel.

    Mr. Ross.

    Mr. Maloney of Connecticut.

    Mr. MALONEY. I have a couple of questions. The first one goes to the issue of experience and the idea that companies are going to learn how to price this risk. It strikes me that 3 years is a very short time to anticipate that to happen. I think it is a short time from a couple of different perspectives. The good news is what the Secretary was alluding to, perhaps there will not be another event; and if there is not, there is no experience from which to price.

    Second, it is a very short timeframe from the perspective of the world we live in. I think it is clear from what I understand of the origins of these attacks, these are the results of historical processes which have been at work for 20-50 years. Bin Laden says 80. My first question is why 3 years? Isn't that far too short, even accepting the model, you say the road taken, even accepting the model for what you advocate, isn't 3 years much, much too short?

    Mr. HUBBARD. This is a double-edged sword. What we wanted was a quickly receding Government presence. So we compromised with the 3-year number. We felt there was enough time for the industry to begin getting experience on pricing. Part of that would come from—since the industry is shouldering slivers of risk, they will try to lay off that risk on the capital markets, and modeling efforts will be used to fill in price, and the natural disaster area will come to bear as well.
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    So is 3 years a magic number? No. But that was our thinking. We wanted something longer than a very short run, but not so long as to intimate a long-term Government presence.

    Mr. MALONEY. So there is no economic analysis behind the 3 years? It is a judgment call? It is sort of a best guess, is what we are being told?

    Mr. HUBBARD. I can give you a fancy answer or a plain answer. The plain answer is this is new terrain. What we can learn by indirect example from the natural disaster area is relatively rapid learning, modeling capabilities to set up a securitization. We are in new terrain. I cannot tell you that period is exact here, but we were comfortable enough after talking with people in the industry and people expert in the disaster area that was a reasonable place to start. If you said 4 years, we would not scream.

    Mr. MALONEY. Let me ask a similar question in regard to the cutoff point of the $100 billion. First of all, if I understand the proposal correctly, at the $100 billion there is no mechanism for payment, there is simply at that point the Treasury will sort of seek the advice of the Congress, and maybe the Congress will do something and maybe it will not. Maybe it will invest in some public improvements or maybe it will not. In terms of the market and the ability of the market to look at it, the $100 billion is the end of the line of any kind of insurance that can be then priced?

    Mr. HUBBARD. I don't think so. I think on the back end, $100 billion was just a sign that we need to go back to the Congress. The obvious political answer is for a disaster that large, we probably are looking at Federal Government intervention. One model we might consider is a Price-Anderson type model.
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    Our view was $100 billion is a sufficiently big event.

    Mr. MALONEY. The follow-on discussion is that that is what the insurance industry is concerned about? At some level the insurance industry, as I understand it, is not as concerned about a $5 billion event or a $10 billion event? There is a sense if that were the level of events, if that were the size and scope of the events, there might not be a need for any bill at all, and that their real concern is when you begin to get to the upper end? That is where the real concern is? The point is if you are asking the market to price something, you have built a cliff, and I am a lawyer and not an economist, but you have built a cliff in this bill that you have some coverage up to $100 billion, and then there is nothing?

    Mr. HUBBARD. No, not that it is nothing.

    Mr. MALONEY. What is it? As I read the bill, it basically says at $100 billion, go talk to the Congress?

    Mr. HUBBARD. Our intent was to try to come up with alternative solutions. As you folks and the Treasury folks work on this, you may specify what that is. I think that from an economic perspective, you want the industry bearing some role, even if it is tiny. Our intent was not to walk away, you are exactly right.

    Chairman BAKER. Mr. Weldon.

    Dr. WELDON. I understand your criticisms of creating a pool which would put the Government in the business of pricing. It would take a lot of capital and just kind of lock it up. I am not sure that is the exact way to describe it, but the way you have laid this proposal out, at the end of 1 year, and the Secretary just testified if there is any first dollar exposure the insurance companies are not going to write it, but if you asked for first dollar exposure in the second year, do you really think in 1 year the insurance companies, and unless we have more experience, how are they going to be able to write premiums to effectively value that level of exposure in just 12 months?
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    Mr. HUBBARD. I don't know what the Secretary said, I was not here. But if you look at year 1 and year 2 in the proposal, our thinking was not just that insurance companies could not do anything in year 1. They can. It is a question of cost.

    For example, if we did nothing, we do not believe that every project in America would go negative. I don't think that will happen at all. Part of our concern was trying to stabilize that supply shock so that there is a small cost to the business sector in the first year. Then the deductible starts in the second year.

    If you decided to have a deductible in year 1, it does not mean that none of this works. It simply means a higher cost and makes it harder for us.

    Dr. WELDON. I want to follow up on something that Mr. Ney asked about in trying to address this through the Tax Code.

    One of the ways I think we can possibly do that if you had an officially declared disaster, the way that the insurance companies pay the tax system and collect on the premiums, they settle on the claims and what is left is taxed. If you had a provision in the law that allowed for, once a terrorist act was declared, that the costs of those claims would then be taken off the corporate tax responsibility, would that not be an easier way to encourage the industry to step up to the plate and start pricing?

    Mr. HUBBARD. I don't think so. I agree with the Secretary's remarks that you do not want to start complicating the Tax Code. If there is a desire to revisit the taxation of insurance, that should be a general question that gets taken up by Congress. We felt that it was more transparent to do it the way we did. We think that the incentive for the industry to go out and build capacity is because of the risk that it is now having to bear.
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    Chairman BAKER. Mrs. Maloney.

    Mrs. MALONEY. I want to thank as a New Yorker the Administration working swiftly on this.

    Given your statement that we are in new terrain and the comments of many of my colleagues, why not a shorter period? Why not say for a year or just getting over the November crisis and then coming back and studying it more. Many of my colleagues are saying that we acted too swiftly on the airline proposals, that we should have thought it through a little better. Why not a shorter frame like a year or even shorter, just getting through November and giving us more time to look at it?

    Second, the bill appears to be written in a way that would give a big incentive to interpret occurrences as terrorist occurences. Politics is everywhere. Earlier the Secretary was saying the Administration should have more leeway. There would be tremendous pressure if there is a crisis in one State to declare something a terrorist act because it would reflect a great deal of money. So how are we going to define it in a way that it does not become something that can be so flexible and that really has more taxpayer exposure?

    Third, why 80 percent of the first $20 billion? Why not 50 percent? 50 percent for the taxpayers and 50 percent for the private industry? How did we get to the 80 percent?

    Lastly, could you share with us some of your thoughts on what happened in England? Apparently they have had this pool insurance policy. Has it been a big liability on taxpayers? Has it worked? What has the experience in Britain been on insuring for terrorism?
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    Mr. HUBBARD. First, I am a fellow New Yorker.

    Mrs. MALONEY. Great. So you are feeling our pain.

    Mr. HUBBARD. I am feeling your pain.

    First, on the question of why not just a year, I think our feeling was in order to give some certainty to the process in commercial lending and the construction of new projects, particularly of concern in Manhattan, that we believe some period longer than a year was necessary. We suggested three. This is not a religious position that it be three, but I think our position was that it be longer than a year.

    On your issue of interpretation of occurrences of terrorism, it is important to have a rigorous definition of a terrorist act.

    Second, a cabinet board or Presidentially directed board, probably consisting of the Attorney General, the Treasury Secretary, perhaps some others at the President's discretion, to make these——

    Mrs. MALONEY. As a Member of the legislative body that has to produce the money, that would put us in a very difficult position, because the President can be put under political pressure to determine that this is a terrorist activity, and then we have to raise taxes to pay for it.

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    Mr. HUBBARD. That is why you want a tight definition of a terrorist act.

    Mrs. MALONEY. I would want to have it shared with the legislative, not just be an Executive Branch decision.

    Mr. HUBBARD. That is something to be worked out in the process. It is not obvious that the same political economy problem does not arise in Congress.

    The third question was the 80/20 versus 50/50. This is not about industry, it is about cost. We picked a position which would have cushioned the cost for business insurance purchases in year 1. You could certainly do it 50/50. That would be a smaller cushion. That is why we made the decision.

    The U.K. pool Re model is a different policy choice. It was a decision actually to have the Government more involved on a long-term basis.

    Mrs. MALONEY. But has it worked? What has been the experience? Has it cost more for consumers? Has it been a successful experience?

    Mr. HUBBARD. The British made a conscious decision to be long term.

    Ms. BAIR. The capitalization at the end of 2000 was 1.3 billion pounds. It was set up to deal with car bombs. We are envisioning significantly greater events.
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    They do financial insolvency regulation. They have a monopoly pricing structure, so they have to have financial integrity regulation. It is quite an apparatus.

    Chairman BAKER. I am sorry, Sheila Bair was never properly introduced. Sheila Bair is the Assistant Secretary for Financial Institutions.

    Mr. Rogers.

    Mr. Miller.

    Mr. Lucas.

    Mr. Toomey.

    Ms. Hart.

    Ms. HART. I just have a couple of questions. Is there anything that you see in here that would encourage private insurers to get back into the market, and I am not saying skyscrapers, say nuclear power plants?

    Mr. HUBBARD. This proposal is related only for terrorism risk insurance, unless you wanted to rethink generally. The simple answer is nuclear power plants are covered under a separate provision of Government intervention.

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    The insurance companies see now an opportunity to deal with business, and the fact that the Government is on the back end of it, the hope is that they will.

    Ms. HART. I didn't get a clear enough answer to Mrs. Maloney's question about the 80/20.

    Mr. HUBBARD. The issue is what is the cost that is going to be borne in premiums. Our judgment is in the short run we wanted to err on the side of being cautious about premium increases for business. That is the 80/20. You could well decide to do 50/50 and stick within the same model. Indeed, you move toward that in later years in our proposal. If you do that, it would be higher cost increases in the short run. That is the tradeoff.

    Ms. HART. Is it based on input from the industry?

    Mr. HUBBARD. We talked with industry and mainly with commercial real estate holders and with large companies about the share of insurance premia in income. You could do 50/50. It would be a larger cost increase.

    Ms. HART. My question is when you made the determination how much the Government would cover, was it based largely on what would make it affordable to the consumer as well as obviously what private insurers would cover?

    Mr. HUBBARD. There were two parts. One, if you think about the outyears, the back end was primarily to focus on catastrophic issues; and in the short run, we deliberately erred on cost increases. That was our first and foremost issue.
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    Chairman BAKER. Mrs. Jones.

    Mrs. JONES OF OHIO. Thank you, Mr. Chairman.

    Mr. Hubbard, you keep saying it is not about the industry, it is about what?

    Mr. HUBBARD. It is about people who buy insurance.

    Mrs. JONES. But people who buy insurance create the industry?

    Mr. HUBBARD. What I mean about it not being about the industry, there is a use, even in the Wall Street Journal editorial pages, which normally I praise, of saying this is a bailout of the industry. That is simply not true. This is a competitive marketplace. What you decide to do is being reflected in premiums that policyholders pay.

    Mrs. JONES. But the basis of us doing this is saying that the people who use the industry will not be able to afford the industry.

    Mr. HUBBARD. It is about the customers of this industry. Insurance companies are just a pass through, as the Secretary explained. They are just a financial intermediary. This is about risk sharing in the economy and the cost of that risk sharing.

    Mrs. JONES. But there is some benefit of being a part of the industry and having an insurance company? That is why people invest in insurance companies because they are a good benefit?
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    Mr. HUBBARD. Absolutely.

    Mrs. JONES. I am trying to make the point that it is about the industry, otherwise we would not be sitting at the table having this discussion about insurance.

    My next question goes to you are saying this intervention should encourage private industry to increase capacity. Elaborate on that for me.

    Mr. HUBBARD. In other words, by creating an incentive to price this; and after all the insurance companies are bearing part of this risk and you have to figure out how to price it, they will have to add capacity for those new lines of business. And they should, prudent business practice, try to lay off some of that risk, both through reinsurance and later to securitize it.

    Mrs. JONES. How do we ensure that the buyers of this insurance, that they will not be priced out of the market when their dollars are undergirding this industry by doing what we do?

    Mr. HUBBARD. Competition. If the taxpayers are on the hook for a fraction of this, that should float through to premiums. If Sheila's insurance company tries to charge too much, I will come in and undercut her. That process keeps insurance prices down.

    Mr. KANJORSKI. If the gentlewoman would yield.

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    Mrs. JONES. Go ahead.

    Mr. KANJORSKI. That all depends on the size of the policy. For a homeowner, there is not going to be competition. If Mrs. Jones' insurance company triples her insurance policy, All-State is not going to try to take that policy. That only happens in large industry?

    Mr. HUBBARD. The process of competition works in mysterious ways, and if you think about something known as long distance telecommunications and aggressive competition on almost a customer-by-customer basis, where there are profit opportunities, people will come.

    Mrs. JONES. I have got two more questions, so I am going to ask you to keep your answers short for me. Compare what you are talking about right now with floodplain insurance. Remember when we couldn't cover—people weren't covered for floods and we began to talk about a 100-year flood, and so forth, and so forth, and so forth, tell me—compare that, if you could.

    Mr. HUBBARD. Well, the disaster insurance doesn't have the same kind of sharing mechanism that we are talking about. It is a subject for another day, would actually be the reform of natural disaster insurance generally.

    Mrs. JONES. Well, forget that question. Tell me—compare what you are talking about—apply the concept you are talking about to what we did for the airline industry and no caps on victims, on the victims of September 11th.
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    Mr. HUBBARD. You mean the whole airline package?

    Mrs. JONES. Yes.

    Mr. HUBBARD. Basically I think what we are doing for aviation—and I say aviation, not airline industry, for the same reason I did before—was you were trying to——

    Mrs. JONES. A semantical. Right?

    Mr. HUBBARD. Not under competition, it is about customers and travelers. The reason for a Government intervention in aviation, we can always argue about the——

    Mrs. JONES. Short.

    Mr. HUBBARD. ——Is to help travelers, and today we think about another industry where business costs are very, very high. Well, part of your response earlier was something about private market participation and putting caps on people's ability to collect claims and so forth and so on. What are you factoring in for the people, the victims in this instance, if you are putting caps on their claims in the insurance industry? And I may not be able to get an answer. Maybe you can give me an answer later on. Am I out of time, or can I get the answer to my question?

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    Chairman BAKER. The time has expired, but if the gentleman wants to respond.

    Mr. HUBBARD. This proposal, or this hopefully soon-to-be proposal, doesn't envision separate victims' funds. That is a separate thing. Is your question about the litigation involving victims or——

    Mrs. JONES. No. In one of your answers, you said the reason we created this proposal was we took into consideration private market participation. We put in caps on people's abilities to make—and you listed six or seven other things that I wasn't——

    Mr. HUBBARD. Yes. Punitive damages was important. To avoid certain litigation costs, you would want to cap non-economic damages and punitive damages.

    Mrs. JONES. But we didn't do that in the airline industry.

    Ms. BAIR. You eliminated——

    Mrs. JONES. But there were no caps.

    Ms. BAIR. We are talking about a $100 billion aggregate cap on payments that the Treasury Department and industry combined would make before we would have—there is the moral obligation, but before we would have to go to Congress. This is an aggregate cap on liability under this program. It is not a cap on tort liability. We believe to manage the litigation process in the event of a major event, there need to be some reforms along the lines of what was in the airline bill, which mainly were claims consolidation and elimination of punitive damages. So, two separate issues. And we were talking about aggregate capping on this.
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    Mrs. JONES. I didn't understand that to be what you were saying.

    Mr. HUBBARD. Yes. The $100 billion is an aggregate cap.

    Mrs. JONES. Thank you, Mr. Chairman.

    Chairman BAKER. Mr. Ose.

    Mr. OSE. Ms. Bair, my question comes to you. I served for a number of years in Florida. The large property casualty issues—also borrow money to build things, and I understand the dilemma we are in. The thing we all struggled with before was providing certainty for the actuarial models. Does Treasury have a definition of a terrorist act that you would suggest we consider?

    Ms. BAIR. We have been giving it a lot of thought and, yes, we are ready to sit down as soon as you would like and share our thoughts on that.

    Mr. OSE. I think that would be very helpful to us. The other question I have is whether the proposal that we have talked about today, is this the President's proposal or is this the Treasury Department's proposal? Is this just an option to consider? What is it we are looking at here?

    Mr. HUBBARD. This is from the President. This is not something the Treasury—that is why we are—this is a White House-adopted, signed off on—this is the Administration's approach.
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    Mr. OSE. I do want to compliment you. The biggest problem we always had was, first, the certainty; then the pricing; and then the processing of claims. And to the extent that this proposal would insulate the Federal Government from getting involved in the processing of claims, a remarkable step for clarity and for the purpose to bring something to the conclusion that goes beyond the understanding of people in this room.

    I do want to encourage you to get us a definition of what the Terrorist Act is. That is the starting point, it would seem to me. What is the Terrorist Act?

    Thank you, Mr. Chairman.

    Chairman BAKER. Thank you, Mr. Ose. I have no further Democrat Members, I think, to be recognized. I would continue on our side. Mr. Fossella? Mr. Shays?

    I just want to conclude by saying how much I appreciate your willingness to participate today.

    Mr. BACHUS. We are going to continue to call him for questioning, yes?

    Chairman BAKER. Well, we have another panel.

    Mr. BACHUS. I haven't had an opportunity to question him.

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    Chairman BAKER. Oh, OK. Well, I went down the list and I didn't let the senior Members ask questions of this panel. One of the concerns that I had in reading an earlier version—and I don't know where the definition is now, not having read it of late. With regard to Mr. Ose's concerns and the definitive circumstance under which an act of terrorism would occur and then looking at the definition, the reading of it at the time was that it was very broad, and I hate the word ''nebulous,'' but it wasn't necessarily very specific; and you could do careful reading of the provision, and I can see where there would be the question of $40, $50, $60 billion at stake, where there might be some legal perspective that would want to take that matter to court for some final determination. I rather suggested that since the nature of these events are extraordinary and unique and unfortunately will remain, I think, in that category no matter what our preparations; that the elements of each event are so unique that that should be a determination by somebody, not a statutory definition, for the principal reason of minimizing the potential for litigation.

    Where we delegate—and the concern I think I heard expressed earlier today, if it were not the President, if it were a board, or we find some team on which this terrible decision would have to be placed. As opposed to a statutory definition, because I have not yet seen—and there may be an artful crafting yet to be done that would eliminate all probabilities—but my observation is that these events are each unique in themselves, and you are not ever going to have a definition of what has already occurred that would make absolute clarity possible.

    Mr. HUBBARD. That is an excellent point. In the whole process of trying to write out a definition, multiple sets of bracketed language, we are struggling with it ourselves. I think the idea of the board is a good one and one that we are pursuing. I think we do want to have some designated board that would make this decision. How much guidance you give that board through the definitions is something that would be worked out.
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    Chairman BAKER. Certainly. Well, if the President or a President's representatives are required to make a declaration of the natural disaster for purposes of FEMA relief, it certainly seems like it should be appropriate in this regard.

    Second, with regard to minimizing the bureaucracies, if the proposal still stands where the 2,300 insurance principles will make the claims for reinsurance reimbursement from the Federal Government—and the Secretary's characterization is we just write checks—even if that were the case, to process several thousand claims with 2,300 providers, merely looking at the forms is going to require I think an ample number of people that we don't now employ to do that work.

    Second, to then audit, as he expressed, the efficacy of the claim and the fact that the person receiving it sustained the damages for which the claim was made is an enormous task. I can well imagine the Federal bureaucracy required to establish that role. Hence, my suggestion that the interface might more appropriately be the commercial reinsurance industry as opposed to the Federal Government's relationship directly to the insurance private delivery system; because the reinsurance market is where the underwriting criteria are established, where the security guards could be required, the doors be replaced, whatever it is that the markets determine are the most advisable to deter additional acts of terrorism, let the market work, and in that event we are not paying money out until after an actual claim has been paid.

    We could then address some of the Members' concerns who have spoken earlier about first dollar coverage or haircuts on both end of the pipe, early and late, and at that juncture then consider the repayment process. And at the end of the day, under the current proposal, the Administration will share in the cost of those events, and we are going to do that by using taxpayer dollars.
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    Now, whether that is a subsidy or a bailout, that is not appropriate. What I am hoping is that we can come to an understanding we are using taxpayer money for a public purpose, but that the taxpayer should not bear the brunt of this for this reason: If we do the liquidity in the market so the economy remains stable and we do it for the economic system, but when they return to profitable and economic conditions are stable, I would hate to think there would be a year in which we would write a check for several million dollars for an industry that at year end reports several million dollars profit. We would not be looked on as very capable stewards of the taxpayers' resources, for this is to facilitate our economic system, not to enable the system to gain the books and make a profit. And I have great concerns about that, the way the structure of the current proposal is put together.

    Mr. HUBBARD. Well, because the proposal is so short term, the Federal Government receives, and then if it has a presence at all, if the Congress wishes, it would be on the back end. And so I don't think you would be in that position. The question you raise would be more for the very short term.

    Chairman BAKER. Well, I would never suggest this, but if I were in the insurance industry and had great PR people, then I would begin today after the passage of the act, begin building a public necessity for permit—engage in a rather significant communications program to say that unless the Congress continues this at even better levels, you are not going to get your coverage. We are going to have to face that one day or another, and I would rather not put into place a system which I think creates unlimited liability without an ability to recoup, in some manner or mechanism, even to the extent of just giving it to the Secretary of the Treasury and say when you think it is right, go get a check. And if it is not right and if it will cause economic turmoil, don't do it. But not give authority to write checks rather without limit, not fully understanding who the check is going to. And look at the interface with commercial reinsurers to minimize that bureaucratic structure. Now I am out of time.
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    Mr. KANJORSKI. They talked about the need for a fair impartial equity board, and by definition, that would rule out the Supreme Court.

    Mr. HUBBARD. No comment.

    Mr. KANJORSKI. No. I am a little bit disturbed in terms of—we seem to be talking about the events of September 11th in New York, and not talking about the recent anthrax problem. And if you look at it, I know I have one constituent in my district who runs a huge mail order house. They officially are out of business as a result of the threat through the mail and the potential closing down of the post office. And if that were to happen, we would have to make sure that we are not insuring all businesses across the country because they can't get their transactions. So we have to be fairly restrictive as to how we write this policy.

    I know my friend from New York, Mr. LaFalce, mentioned business cessation, but there is no way that we could recover that kind of losses. A catastrophic event, even of a minimal nature, would rule that out.

    I am disturbed that we are not thinking about other type events. This is not just something that is going to be concentrated in one area, but very easily could end up being a nuclear stockpile, a waste facility that probably in one event out of 104 nuclear plants, are likely to cause hundreds of billions of dollars of damage. I think that should be included, because, you know, we can't go to the limitations of policies on nuclear plants—I think is $7 billion—and then we have 102* an $300 billion dollars and a million people killed or radiated and we have no coverage.
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    But one of the things that really disturbed me about our failure to think this through to a large extent—and I don't want to push on you and then the Administration—is that the airline bill, the compensation act I think is atrocious. It is indefensible, because it wasn't thought out, it wasn't properly presented. We had 15 minutes, I believe, to read the bill beforehand. I almost had a heart attack as a former tort lawyer as to the potential liability. As I told Sheila, someday in the not too distant future, the Treasury is going to be writing out $1- and $2- and $3-billion checks to single estates in the United States Treasury. I don't think that was ever the intent of Congress, and yet the Administration hasn't come forward with a terrorist victims' compensation act. We have already had four or five deaths, and these people were in the service of this Government. They were the direct result of terrorist activity, and because they don't have contingent liability to have to go to banks, they are not going to get airline protection unless we do something about it.

    And we have got a great time to do it right now. With this bill—I agree we are not bailing out the insurance company, but we sure as hell are encouraging business and providing a reduced cost of business. If we are going to do that, we ought to make sure that we compensate some of these people that are directly or indirectly affected in their life and person from the tragedies that are occurring and will occur in the future. I think it is absolutely incumbent upon the Administration to face that.

    I also encourage the Administration to revisit the compensation act. I just believe we have to have limitations on this thing. To pay a bond trader that died in that building $3 billion when we are not compensating the people that died in Oklahoma City as a result of the terrorist act, that we won't be compensating these postal people that are dying all over the country, that is ludicrous and unacceptable, and we have to get out of a mind-set of just thinking about money for bricks and mortar. There are more people that could be hurt, and will be hurt, in terrorist activities in this country that deserve the total feeling of the taxpayers in the entire country to provide some compensation, not to make them wealthy, but to make them as near whole so that they can exist with their loss as possible. So I think we really have to study that. And in reality, we will be saving the taxpayers money when we do go back and find out how we can put a cap on this exposure.
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    Mr. OSE. Will the gentleman yield?

    Mr. KANJORSKI. Yes.

    Mr. OSE. When Paul talks about this, one of the questions that comes to my mind is with what happened on September 11th, one, two, or three terrorist acts, and I think that is right in the middle of your questioning, and we don't know what the answer to that is, and if it is 1, you know, the limitations on the policy are X; but if it is 2, it is twice a big as pi; or if it is 3, it is 3 times as big.

    Chairman BAKER. 3.6 at risk if it is one event. 7.2 if it is two events.

    Mr. KANJORSKI. Right now we are really trying to insure bricks and mortar and not people. After all, if the General Motors plant gets wiped out, it may be a $10-, $20-billion disaster. I would hate like hell to see a check for $20 billion going to General Motors when there are 2,000 families that lost their breath—and if we can send people in harm's way over to Afghanistan and only have a liability of $250,000 with them, we have to provide the soldiers on the homefront with some liability. And we shouldn't have unlimited liability or compensation for people that have to die in New York.

    And I feel very sorry for them, but we are not to make them totally whole. That was never the intention, should never be the intention of the United States Government, because it is just incredibly—that liability, $30 to $70 billion, that is an awful lot of money. It should be used in other anticipatory events. And I guess with that I will——
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    Chairman BAKER. Your time has expired.

    We are going to have to step out for a vote on the floor. I believe Mr. Bachus indicated to ask his question. On the conclusions of Mr. Bachus' questions, he will have to come up to the floor for the next vote. The bad news is for the next panel, I am told, that the votes that are now pending will keep us 20 minutes. And then we will reconvene for our final group. It has been suggested that we just delay the third panel and conclude that tomorrow, but I haven't had a chance to talk to Mr. Kanjorski about it. If you are here, I suspect many of you would like to go ahead. With that, I recognize Mr. Bachus in the chair, and we will return in a moment.

    Mr. BACHUS. [Presiding.] Mr. Hubbard—and I think some of these questions have just been asked—there has been a significant blurring of the line between acts of terrorism and—between acts of terrorism and acts of war, and I don't know that anything in this will clear it up. Will a future attack by Usama bin Laden's network be covered by the Administration's proposal?

    Mr. HUBBARD. Well, formally what we have been looking at is the war being mutually declared, more a formal declaration of war as opposed to a terrorist act. I agree with you, including the President's own rhetoric, maybe the impression of a blurred line between war and terrorism is certainly an open question.

    Mr. BACHUS. Another attack by this network or another terrorist network. And if we don't clarify what this Government—I mean, if it doesn't cover acts of war, then——
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    Mr. HUBBARD. At least under the current definitions, another bin Laden attack and the present lack of a declared war would qualify as a terrorist act.

    Mr. BACHUS. How about by the Taliban?

    Ms. BAIR. No, we have decided that our current thinking is to have a bright line with a U.S.-declared war and——

    Mr. BACHUS. The other thing, and I am not sure I disagree, but public policy questions have got to be what this Congress is going to do about health and life insurance coverage. If it is written to exclude terrorist acts, it is going to affect an awful lot of people, particularly when we are stepping in and procuring commercial law, not health law.

    Mr. HUBBARD. We felt that at the moment, we wanted to focus narrowly on P&C laws, one of which is workmans' compensation, so there is some health related. What isn't is other health insurance. My impression of the HIA folks is that at least at the moment, to not exercise—they are——

    Mr. BACHUS. That is something that we probably ought to at some point take up.

    Ms. BAIR. There doesn't appear to be an obstruction of the market for life and health right now.

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    Mr. BACHUS. You are talking about the short term, and you want to get into the short term and do something, and the long term that the market ought to take care of. Let us assume that—should there be tax incentives for the private sector to build reserves against terrorist groups? That is not in here.

    Mr. HUBBARD. No. That's right. We felt that we should just go more directly with the sharing scheme in the short run. I don't think it is a wise idea to distort the Tax Code. I think we can more explicitly——

    Mr. BACHUS. Well, you know, what you do is a 3-year deal, but at the same time, when people finance property, they finance 10 years, 20 years, and 30 years.

    Mr. HUBBARD. That is true, but nobody guarantees you insurance over 10, 20 or 30—all insurance has features or rate change features. I think the idea was to give the industry time.

    Mr. BACHUS. If they are going to finance property and—will a 3-year plan actually cause them to bill that—to finance that property, when, you know, they are going to be financing it over 10 years or 15 years or 20 years? And what I am thinking, you know, have a 1-year plan, but come with some Government backstop is a better proposal than what you have here, and then you are not getting the Government as involved in the second and third—creating some backstop.

    Mr. HUBBARD. Well, our hope is that 3 years would be enough time that the industry would have developed better pricing methodologies going forward. If you do just the year, our concern was that you are having an almost freezing in place for a year while people wonder what the Congress will do.
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    Mr. BACHUS. Another terrorist attack, another terrorist attack, this 3 years is going to turn into 6 years and it is going to continue to be pushed back. I am just saying that—backstop as part of a long-term solution.

    Mr. HUBBARD. You should defensively do a backstop for a long-term solution. The question is the short term.

    Mr. BACHUS. Should an insurance company's eligibility for the program be conditioned on providing terrorist risk insurance in all its P&C policies? You are not doing that in here.

    Mr. HUBBARD. Well, it is an open question, actually, whether this is mandatory or not.

    Mr. BACHUS. You mean legislation? We are not sure about looking at the legislation?

    Mr. HUBBARD. No. I think it is an open question in this process whether you want to make it mandatory or not. One school of thought would be that——

    Mr. BACHUS. Require P&C insurance to provide——

    Mr. HUBBARD. Well, that would be a step that you could take.
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    Mr. BACHUS. Is the Administration open to that?

    Mr. HUBBARD. We are looking at all these options.

    Mr. BACHUS. You haven't rejected that option.

    Mr. HUBBARD. No.

    Mr. BACHUS. Particularly if the Government is going to be involved in a matter of public policy, if we are going to get involved in it, we want to make insurance affordable and available. And if we don't, and if we allow P&C companies to only select certain risk and—more high risk—to me it doesn't get—utilities, things of that nature.

    Mr. HUBBARD. I agree. The tension was the Federal versus State aspects of the insurance industry in the U.S., but I agree with you in principle that that is a concern.

    Mr. BACHUS. And I am just saying if the Government is going to get involved, the Government ought to say, you know, you offer it and you make it available.

    Ms. BAIR. I would just say I think we thoroughly discussed that, and you might want to pose that question to them. I think there are a couple of questions. One is do you want to require that all P&C insurers provide the coverage, or do you just want to say it has to be a standard part of the P&C policy?
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    Mr. BACHUS. Well, you could. So your eligibility to participate in this program——

    Ms. BAIR. Well, you still have an adverse——

    Mr. BACHUS. You don't have to provide that coverage, but if you don't provide that coverage, you don't participate in this program, because the program's design is to make that coverage available. And why allow someone who has no intention of providing that coverage to participate in the program; or has existing coverage, perhaps for the next year that is already written, but, you know, they have no intention of rewriting it?

    Ms. BAIR. I think the 20/80 approach in the first year reduces the incentive for insurers to cherry-pick.

    Mr. BACHUS. Well, a better incentive would be just a requirement that they participate in the program. And I would rather do that than constitutionally tell them they have to provide it. I think if they participate in the program, they have to.

    Ms. BAIR. Yes.

    Mr. BACHUS. You know, the British plan, their contribution—well, let me just say this. What about an ex-post subsidy? You know, for our cause, would you consider that?
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    Mr. HUBBARD. Priced how?

    Mr. BACHUS. I don't know. Just give maybe the Secretary some discretionary authority to charge assessments based on some of the—to recoup any losses associated with administering the program.

    Mr. HUBBARD. But then you are not encouraging the private industries' ability to price. I think our——

    Mr. BACHUS. No, I agree.

    Mr. HUBBARD. Our prejudice is the private industry could——

    Mr. BACHUS. Yes. Thank you both for your testimony. I would now like to bring our third panel up.

    We have a distinguished panel, and I always feel sorry for the third panel of any day, but particularly today, I know some of you came from out of town, in these wonderful quarters we are having for this hearing. But all that aside, we truly appreciate your being here, and I am subbing for Chairman Baker until he returns. But we wanted to give you folks an opportunity to testify and for the panel to ask questions.

    Let me begin just to introduce the panel: Mr. David Mathis, Chairman and CEO of the Kemper Insurance Companies; Mr. Constantinos Iordanou—I always mess up this—Iordanou, Senior Executive Vice President of Group Operations and Business Development for the Zurich Financial Services Group; Scott Harrington, Professor of Insurance and Finance, Moore School of Business, University of South Carolina; Mr. J. David Cummins, Harry J. Loman Professor of Insurance and Risk Management at the Wharton School at the University of Pennsylvania; Mr. David Keating of the National Taxpayers Union; Mr. John T. Sinnott, Chairman and CEO of Marsh, Inc; Mr. Roy A. Williams, Director of Aviation from the Lewis Armstrong New Orleans International Airport; Mr. Richard J. Hillman, the Director of Financial Markets and Community Investment, U.S. General Accounting Office; and Ms. Marjorie S. Nordlinger, Senior Attorney, Office of the General Counsel, Nuclear Regulatory Commission.
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    Thank you all for your patience under these very difficult circumstances.

    We will begin with the gentleman from Chicago, Mr. Mathis.


    Mr. MATHIS. Thank you. Thank you all for allowing us to attend. Having listened to some of the presentations today and having seen some of the other presentations earlier, I am going to cut short some of the comments that I would make in order to allow more time for questions and answers at the end. I do want to point out that Kemper is a large property and casualty insurance company, based in Chicago, with offices throughout the United States and in many foreign countries. Our largest line of business is workers' compensation coverage, but we also are a prominent writer of commercial coverages for a variety of businesses, from Main Street operations to mid-sized firms and to Fortune 500 companies.

    I would point out also that as a structure, we are a mutual insurance company owned by our policyholders as opposed to being owned by the stockholders.

    Skipping forward, I would mention that Kemper, like other property and casualty insurers, has been steadfastly committed to meeting our promises to policyholders as a result of the September 11 event. Our pretax losses are estimated at $360 million gross and $60 to $80 million net of reinsurance. I mentioned the two figures, because as we go forward I think it is interesting to keep in mind that absent reinsurance in this type of event, we would be looking at a $440 million loss as opposed to an $80 million loss. So the function of reinsurance has been important and continues to be important for the industry. While that is a significant sum, we will continue to meet our obligations to policyholders with no difficulties, and that includes the payment from our reinsurers as we go forward. For the industry as a whole, we are looking at losses from $30- to $60-billion, although the final number will not be known for some time.
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    Although no natural disaster or, for that matter, man-made catastrophe even comes close, for the sake of reference, I would note that Hurricane Andrew, which devastated south Florida, caused approximately $19 billion in insured losses, perhaps half compared to the September 11th losses. Put another way, the September 11 losses will exceed the entire property and casualty insurance net income for the past 3 years, 1999, 2000 and 2001. In just one day, industry profits for 3 years were wiped out, depleting investment income.

    Recognizing that the American people and our economy will recover and move onward, we also are looking ahead. And although the property and casualty insurance industry can deal with the incredible loss of September 11th, we are very concerned about what will happen if additional large-scale terrorist acts in the future occur. It is critical that you as public policymakers share our recognition that terrorism currently presents four challenges to the insurance marketplace which we cannot meet. It is crucial that everyone recognize that we are dealing with a peril that is at this stage not quantifiable and therefore not insurable within the finite resources of the insurance industry. Quite simply, the financial capacity of the industry is limited, and unfortunately, the potential harm that terrorists may inflict is unpredictable in frequency and unlimited in severity. Given this mismatch, insurers and reinsurers cannot assess, measure or spread the risk of terrorism. As a result, terrorism has become uninsurable in the private market. This insurance market crisis, and, by its extension, pending economic crisis is why we are all here today.

    As you probably are aware, more than two-thirds of the annual reinsurance agreements—and we have all talked about that—by which primary insurance companies purchase their own insurance to adequately spread risk are renewed as of January 1, and reinsurers have already notified primary carriers that the reinsurance contracts coming up for renewal will provide no coverage for terrorism. And although the primary insurance sector in the industry is adversely affected by such decisions, we recognize that this may well be the reinsurers' only way to protect against insolvency themselves.
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    Primary carriers, however, do not have the same flexibility as reinsurers with respect to their own products, because we are subject to tighter regulatory oversight. Any terrorism exclusion we might choose to introduce must be approved by individual State regulators. If approved, our customers could find them bearing 100 percent of the risk associated with terrorism, and certainly the repercussions of this are clear. However, if exclusions are not approved, primary insurers would be left to shoulder 100 percent of future terrorist losses, which we cannot do.

    Allow me to give you an example of and to illustrate the higher retention of risk imposed on the industry. One of the Members of the subcommittee mentioned that we were not involved in dealing with lives here. We specialize in workers' compensation sector business, which significantly deals with lives. And let us say that an insurer provides workers' compensation coverage for a manufacturing facility with 6,000 employees. The plant in my example would not be located near an earthquake fault or any other place where a natural disaster caused a workforce loss of life. If, God forbid, that plant would be targeted by an extreme terrorist act which takes the lives of all the employees, the workers' compensation claim, depending on the State where the plant is located, could run between $2.5 billion to $3 billion and could fall on that individual insurer without reinsurance.

    Chairman BAKER. I hate to interrupt you, but for the sake of the proceeding, on the panel I would ask that everybody try to prepare your remarks, revise them to, like, a 5-minute limit. We will incorporate the full statement into the record, and to give you a minute to collect your thoughts, if you could begin to summarize for us, because we will have other Members coming back, and it is going to be a lengthy evening for us if everybody wants to ask everybody questions.
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    Mr. MATHIS. I will do it without notes. Let me just say that a basic part of our discussion has been associated with trying to find a means where the industry would spread risk and could get a backup to replace the reinsurance mechanism. In our instance, I think the major issue that should be kept in mind really relates to four points. One is that the larger the amount of risk that the industry is forced to retain, without an adequate ability to spread that risk, will create a dislocation by individual companies. And that was the reason that the industry put forward a proposal to spread the risk and provide a Federal Government backstop.

    Second, the industry needs to be in a position where it can pass rate increases on, in terms of any kind of charges for whatever net retention or, for that matter, whatever charge the Government may impose for its backup in terms of reinsurance. So any Federal legislation should provide some State regulatory preemption to allow that rate regulation to go through.

    Third, the industry would need to be consistent in its wording for terrorism, not only with the Federal Government, but also with each insurance policy, and as a pass-through to the reinsurance industry as well. If you have a different definition of terrorism, which is excluded in the reinsurance industry, the industry would have no recourse but to underwrite against the biggest potential loss or net losses to the company.

    And finally, the industry would need to have some measure of giving credit for any kind of reinsurance. So, bottom line, the industry needs to find a way to spread risk. We do not think that all of the proposals that are presented allow us to do that.

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    Chairman BAKER. Thank you very much.

    Please excuse me, is it Iordanou?

    Mr. IORDANOU. Yes. It is a Greek name.


    Mr. IORDANOU. Chairman Baker, Chairman Oxley, it is a pleasure to be here. Zurich is a multinational insurer of significant size. We operate in 60 countries with $20 billion in equity capital. We have significant operations in the U.S.

    The event of September 11th will cost consumers anywhere between $700 and $900 million in losses. This is net of reinsurance. If we would have counted our direct loss absent of any reinsurance protection, that would have been significantly higher, probably approaching $2 billion. Clearly, these are substantial amounts, but, however, Zurich in its strength with its global capital base can absorb these losses without any long-term financial implications for us, assuming there is no subsequent event of a size and assuming that we continue to have the ability to protect our balance sheet reinsurance purchases.

    I will tell you today that we have notifications from all of our reinsurers that as of January 1, coverage for terrorist acts will be excluded from our reinsurance. So what does that mean? Unfortunately, for us it means that at a time when our customers need this coverage the most, not all the customers, but our largest and our smaller customers are being told by us that they cannot renew their insurance coverage absent some way of excluding terrorist risk. The larger ones have been told so because they represent very high-dollar risks to a single location and the smaller ones are being told so because the potential of risk in a particular territory creates the same issue.
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    This is a new economic reality, which is sad, but very real, and we need to deal with it. We now have such drastic steps——

    Chairman BAKER. We are sorry. We are just trying to figure out strategy on the votes we have, just so we can dispel this. We are going to wait and run up to the—so we will go 5 minutes.

    Mr. IORDANOU. Without the drastic steps that Zurich is taking to protect its balance sheet, but at the expense of our customers, we can't continue to assume these kinds of risks.

    The private sector, in my view, is the way to respond to the situation and could potentially fill the void with some normal risk management tools. However, the cost to the Zurich for such tools will be prohibitive, and they will fail to provide sufficient capacity to address the multiexposures that the U.S. economy faces today.

    Any Government solution should measure and should focus on bringing sufficient stability back to the insurance market so that companies like Zurich will feel comfortable including coverage for terrorist exposures to its risk portfolio.

    I would remind the subcommittee that the essence of insurance is to efficiently apply capital to risk, so the standard way in which we determine whatever that goal has been met will be to whatever the degree and concentration of capital exposed to future terrorist acts is manageable. Too much exposure will force insurance to continue excluding terrorists from their coverages. However, we also appreciate that too much taxpayer exposure results are unacceptable. The solution, in our view, will need to balance the market's need for maximum stability with the Government's need for minimum exposure to these types of risk and involvement in the free marketplace.
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    I, for one, am confident that such a balance exists and would urge all participants to move this debate to focus on the common themes embedded in the options offered to date instead of the shared shortcomings we see in those options.

    For example, the industry's original proposal utilized a pooling concept utilized a pooling structure, an approach that has longstanding use within the industry and has served other nations well in their quest to address the economic realities of terrorist risks. We understand while the concerns have been expressed, and that the debate has moved beyond this proposal, but the underlying concept of facilitating the spreading of this new type of risk is an important one that should not be abandoned. Ultimately the success or failure of this effort will be judged in the marketplace on a risk-by-risk basis, not by some broad industry aggregate, so there might be some component that serves as a proxy, even in the medium term, to the traditional reinsurance mechanism.

    The White House has quoted a different approach that utilizes a pro rata risk sharing concept. It is a short-term stop-gap measure that increases the private sector retention in the second or third year, probably to the levels that are beyond the industry's capability to handle. Plus, there are a number of operational questions that would need to be answered before judging the effectiveness of this approach. However, the proposal effectively spreads both the risk and aggregate exposures that the industry is facing and signals a very important recognition on the part of the Administration that the Government does have a role to play in managing what are fundamentally political risks in our view.

    Both proposals, then, reflect the underlying concept of shared private and public sector responsibility, and with modifications—some major, some minor—could serve as the basis of a meaningful resolution to this problem.
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    In closing, I would suggest that anyone who views a thorough backstop as a bailout may be underestimating the discipline of the private marketplace. The actions Zurich and other insurers have taken to minimize their exposure to terrorism are firmly in line with economic reality. Our capital is finite, but the risk is infinite. Thus, if there is any ''bailing'' out occurring, it is the natural tendency and expected flight of capital away from terrorism risk. This should not be surprising, since it is how markets operate in general, and it reflects an immediate manifestation of how the capital markets are responding to the ''new normalcy'' of post-September 11th American life.

    Thank you for allowing me the time to present to you Zurich's perspective, and I would be happy to answer questions.

    Chairman BAKER. Thank you very much.

    What time do we have remaining? If we would, Mr. Harrington, we will recognize you, Professor of Insurance and Finance, University of South Carolina. Welcome.


    Mr. HARRINGTON. Chairman Baker, Mr. Oxley. I spent my career studying insurance, and I really appreciate the opportunity to be here to have this opportunity to testify.
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    We don't know how bad things are going to get this winter when these contracts are ultimately—we don't just know yet. Some Federal intervention may be very desirable to prevent a potential crisis. But we need to consider very carefully—insurance involves the fundamental tension between risk sharing and incentives—you have heard a little bit about this today. We widely appreciate the incentives of risk sharing. The moral hazard effects are likely less appreciated. It tends to dull incentives to manage risk. At this time, private markets do a tolerably good job of dealing with moral hazard.

    Government insurance programs or Government-backed insurance mechanisms—they are also not likely to provide good incentives for efficient claims management. They are not going to provide the right incentives for risk management in the private sector.

    Subsidized Federal reinsurance or direct Federal reimbursement of a large proportion of terrorist losses could make citizens more vulnerable to harm. And, again, it could make citizens more vulnerable to harm. If insurance against terrorist acts is made available at heavily-subsidized rates, some—perhaps many—businesses could take far fewer precautions to protect life and property. If you help too much, there is a good chance that more property will be destroyed and more people will, in fact, die.

    The Administration's proposal has some advantages. It might keep the Federal Government out of pricing insurance; but then, it might not, because if you start thinking about mandating the offer of such coverage, I think you are going to pretty quickly have to think about limiting price. It could be awkward.
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    I think the Administration's proposal would provide some limited subsidy to the insurance industry. It would provide some significant subsidies to large commercial property owners. I think the major problem is the first dollar coverage at an 80 percent basis. Professor Hubbard said that they wanted to err on the side of caution. They erred on the side of too much precautionary risk spreading. That proposal would seriously undermine the integrity of risk assessment, claims adjustment, and management. And the proposal does relatively little to encourage capacity. In fact, I think it does very little to encourage capacity.

    I encourage you to consider two things. One is some form of tax incentives for insurance companies to build the massive amounts of capital it takes to write this stuff. We are not talking about distorting the Tax Code. The Tax Code distorts these markets immensely. It is a punitive tax on the private sector. If we are going to try and help these markets accumulate capital, then we need to remove some of that punitive taxation.

    I think you could encourage supply substantially with some form of temporary system of ex-post assessments. Let me just step through that very quickly. You might have a system where, with $5- or $10-billion in terrorist losses in a year, God forbid, that insurance companies, all property casualty insurance companies, will be assessed to finance a material proportion of the losses above that threshold. The insurance companies could limit their risk. We could allow them to borrow from the Treasury if the assessments in any given year exceeded some amount like 2 percent of the premiums. They could pay back the amount that they borrowed with future assessments under that type of proposal, if necessary, at a higher threshold. The Government could then become a direct sharer in the risk bearing.

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    In conclusion, I think the tax incentive approach and the possibility of ex-post assessment of the insurance industry would help mitigate the threat of a crisis and mitigate these inherent problems without substantial undermining of private sector risk assessment, claims settlement, and risk management, and I really think that the result could be less loss of property and less loss of life. Thank you.

    Chairman BAKER. Thank you very much.

    I think we are going to call our next witness and proceed before we depart for the vote. So Mr. David Cummins, Professor of Insurance and Risk Management at the Wharton School.


    Mr. CUMMINS. I would like to thank the Chairman and subcommittee Members for allowing me to be here today. I have outlined some principles that I think any Federal program should satisfy, and to say at the outset that they are more consistent with the Administration plan than they are with the private insurance industry plan. I am basically very much opposed to the private industry plan. I think the Administration plan has a number of features to recommend it, but there are a number of features or problems that would have to be fixed before it would be enacted and be really an effective program.

    I think, first of all, the program should have the clearly stated objectives of helping the policyholders, insurers, and the economy to weather the current crisis by encouraging private insurers to return to the market as soon as possible.
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    Second, the Federal program should avoid the creation of any new institutions or new bureaucracies, such as the homeland security insurance company proposed by the industry.

    Third, the Federal contracts have to be sold at a positive price. Providing free coverage would set off all the wrong incentives in terms of claims settlement and charging premiums in the direct market. So you have to come up with a price. I would recommend hiring an actuarial firm to apply the principles of actuarial science to come up with the best possible price under the uncertainties that we know are present in the program.

    Fourth—and this is a commendable part of the Administration's proposal—that any Federal coverage should have a cost sharing provision, where the Government should never cover 100 percent of any layers. So it should at least be 20 percent covered by the industry, or maybe even more than that, except possibly at the very highest layers.

    Fifth, Federal coverage should start after a reasonably large deductible. There should be no first dollar coverage, even during the first year. The industry could easily bear $5- to $10-billion. That is not the layer that they are really concerned about, and it sets the wrong incentives to provide Federal first dollar coverage.

    Sixth, the Federal obligation should be capped. There is no magic number, but $100 billion is probably reasonable; perhaps something somewhat less than that would also be a possibility. And this basically gives the Congress the option to come back in at the $100 billion layer and either agree to continue or extend the program or decide to do something else. You don't want to put an unlimited program in place.
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    Seven, the program should be limited to property coverage——

    Chairman BAKER. Just stop for a moment. We will put Mr. Bachus in the chair. We will be right back.

    Mr. CUMMINS. The coverage should be limited to property coverage and other coverage to terrorism where the loss amounts are relatively easy to identify. For example, the program should not provide coverage for difficult-to-verify claims such as business interruption insurance. This is to prevent abuse of the Federal program and to provide incentives for policyholders to get back in business as quickly as possible following a loss. There may be the need for other policy remedies, especially for small businesses facing business interruption crises, but it shouldn't be a part of the insurance program.

    Consideration should be given to incorporating ''finite reinsurance'' provisions in any Federal plan. Essentially finite reinsurance transfers less risk to the reinsurer than traditional indemnity reinsurance that is basically intended to smooth out the insurers' losses over time. The reinsurer essentially advances money to the insurance company when losses are high, with the obligation of the insurer to repay most of the money when losses are relatively low. This might be especially appropriate in a Federal plan at the lower layers of coverage.

    And then finally, the Government should explore ways in which it could encourage the development of private markets for catastrophic risk without providing Federal backing, such as lowering regulatory barriers to securitize the insurance risk, and perhaps acting as a facilitator of securitization by providing data that could be used by private firms in developing better loss indices to enable the provision of securitized financial instruments which are much more efficient than insurance in insuring this type of risk.
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    So I guess just a couple comments on the Administration proposal. Several things I see wrong with it. First is providing first dollar coverage during the initial year is not a good idea. The industry should bear the first $10 billion of coverage.

    Second, without going into each year and each layer, case by case, the proposal is generally too generous, and it is split between the Government share and the industry share.

    Third, the finite reinsurance option should be seriously considered for lower layers of coverage, with the indemnity reinsurance going to the higher layers.

    And then, fourth, the program should exclude certain types of difficult-to-verify claims, such as business interruption insurance.

    And then also it is important to charge a premium for the coverage. Thank you.

    Mr. BACHUS. [Presiding.] And their proposal does exclude businesses. Right?

    Mr. CUMMINS. It excludes punitive damages.

    Mr. BACHUS. My understanding is the last draft took out that. Well, I think it is going to, if it hasn't, as a result of the testimony today.
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    Mr. Keating.


    Mr. KEATING. Mr. Chairman, thank you for the invitation to speak before the subcommittee today. We represent 335,000 members, and we are strongly opposed to the insurance industry proposal and the Administration proposal, at least as it has been offered. I would like to associate our views with what I have heard both from Professor Harrington and Professor Cummins. All of the concerns that they have raised, all the points that they both made I think were excellent, and the subcommittee should keep them foremost in your mind as you go to draft any legislation.

    We wholeheartedly agree that both these proposals stand the risk not only pf putting taxpayers in danger of unnecessary losses of human life and property, and I didn't hear much—and much to my disappointment—from the Treasury Secretary or Mr. Hubbard about that, and I think that most people agree human life is the key thing that we should be watching here. And we need to have incentives for the people in the industry to watch their clients to see that they are putting forth the proper security measures, escape mechanisms and such, and if we just give away Federal reinsurance, we are not going to see that kind of activity taking place and clearly we need to have that kind of activity. People need to reassess how they are running their businesses.

    It is essential that we limit the Government's total liabilities in any action or legislation, that you make firm limits or policy, clearly define terrorism, and limit the Government's exposure to certain types of losses. We are very concerned about business interruption coverage. Otherwise we could see the Government paying companies not to go back to work for years.
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    We see the same problems with unemployment insurance. I mean, people don't have the same incentive to go get a new job if the Government is underwriting their business revenues even though you are not in business. Things are very vague and can be stretched out. We can't go there.

    We also have to make sure insurers pay enough of the claims out of their own pocket. Otherwise they are going to make their long-term clients happy with Federal Government taxpayer dollars. Easiest thing in the world to make someone happy with someone else's money.

    Now, I also want to express my surprise and shock about the Treasury Secretary, of all people, and the Chairman of the Council of Economic Advisers, their understanding of tax laws regarding insurance. To me it is astonishing that they think that somehow allowing reserving on a tax-free basis for the expected losses from catastrophes is somehow a distortion of the tax laws. They have got it exactly backward. The tax laws are what are distorting sound insurance principles here. If we knew with precision what the future would bring, we could set aside the money now, the exact correct amount, so that when the disaster happens, the money would be there. If you guide it by years, you know it is the cost of doing business; yet the way the tax laws are written, that cost of doing business is counted as a profit and taxed. It is crazy.

    So I think they have got it exactly backward, and Members that had asked about that, perhaps you are using the wrong language. Maybe they heard the question wrong. It is not so much we need a tax incentive. Should we stop the tax penalty for sound reserving catastrophes? That is the way I would ask the question and perhaps you would get a different answer next time.
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    Rather than discuss point by point what we have in front of us from the industry to the station, I would like to outline some principles for legislation. One.

    One is, I think this is obvious, any Federal capacity should offer the maximum amount of economic benefit, not only to the Nation, but injured parties, at the lowest cost to the taxpayers.

    Two, legislation must not erode incentives for wise underwriting and insurance company management of risk, proper security escape contingency plans I spoke of earlier. We cannot have a blank Federal reinsurance check and reduce incentives for increased security.

    Three, if Federal reinsurance capacity is offered, then there should be payment for the use of capital and the assumption of risk, for many of the reasons I spoke of earlier.

    Four, Federal coverage should certainly not insure against all industry terrorism losses. Coverage in the first dollar of losses is unnecessary and unwise, because it would erode incentives and increase security.

    Fifth, Federal insurance capacity should be temporary to maximize the use of market mechanism, first for reentry of prior reinsurance at higher levels at the earliest possible date.

    Six, legislation must contain strong incentives to pay only valid claims. We believe the Federal Government's copayment claims should never exceed 80 percent. As spoken of earlier, it is too easy to make other people happy with someone else's money, in this case the Federal Government's.
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    Seven, and this is a point I haven't heard yet today, maybe it is so obvious that no one has spoken of it, but I am not sure so I will say it. The Federal Government's exposure should be capped primarily to preserve America's national security options. Let us face it, we are in a war. We don't want to have a Federal Government entitlement program to underwrite every dollar of every damage that might happen. We are not facing the bombing of London like they did during World War II, but if something terrible should happen here, we can't have a Federal entitlement program to cover every dollar of loss for war or terrorist attacks.

    So I am not even sure where the definition is, but the primary purpose of the Government is to defend our Nation. So we cannot have an unlimited liability, and that is one positive trait in this Administration proposal. We will have to balance off what we can do for our Nation's people, their property losses, the lives that are lost, but we also have to balance the key reason for Government, to defend the country. So that is the real reason why it needs to be capped.

    Another principle that the Administration has talked about and we agree with, we need some sort of panel to quickly pay and settle claims to incur losses in a fair and inexpensive way. We don't want to spend taxpayer money paying the trial lawyer a lot of money, stretching out litigation years and years. If the private markets were to get back and cover this kind of loss, they need to know what the loss is. We can't stretch it out over the 5 or 10 years, figure out what the eventual losses are, and we don't need to waste money paying a lot of lawyers to do this.

    So those I think are the key principles. I think by—listening to those principles and applying them to the proposals before you I think will help steer the subcommittee and the Congress in the proper direction, and we are willing to work with you, Mr. Chairman, other people in the industry, other interested parties to help work out a solution here. Thank you very much for the invitation.
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    Chairman BAKER. Thank you.

    Mr. John Sinnott. You are Chairman and CEO of Marsh, Incorporated.


    Mr. SINNOTT. Thank you, Mr. Chairman, for allowing me to be here. I should probably explain what Marsh, Inc., is, because we represent, perhaps a slightly different constituency than others. We are the world's largest risk adviser and insurance broker. We have about 35,000 employees around the world, and we are located in about a hundred countries. Our clients comprise all segments of the commercial world. Private clients also. And we also act as advisors and reinsurance brokers to insurance companies. So I think that we have a pretty good view of what is happening today in this marketplace and what we expect will happen for our clients if something doesn't happen here very quickly.

    I should also point out that I represent not just Marsh, Inc., but I also represent the member firms of the Council of Insurance Agents and Brokers which is the national trade association. So I am speaking for both constituents. I will cut through some of the comments that I had planned to make. There are two problems here. One is the size of this event, which is more than twice the size of the next largest catastrophic event. If you add the other five largest events that took place in the last 10 years, you have only about aggregated what the estimated loss coming out of this particular event is.

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    The second problem is the uncertainty of the current environment. That is what is different since September 11th and why we are talking about this issue now. The nature of this risk has radically changed because of certainly a perception of what we have heard from Washington which is the probability that there will be another event. So trying to compare the way we approach this pre-September 11th and today you will never come up with the right answer.

    What is the result of these two problems? Since September 11th, we have undertaken many renewals on behalf of our clients, and most reinsurance is still in place, although we are seeing terrorist exclusions on the policies more so than not. And the other thing that I can say, as we look forward to January 1st, our reinsurance unit cannot identify a reinsurance company that is not going to exclude terrorism come January 1. So the issue of this is not an issue of supporting the industry, but the fact that American business will not have protection for a catastrophic potential loss come January 1st.

    I would disagree with the comments about business interruption. Business interruption is a normal sort of risk that business clients transfer to others. It will comprise a significant part of the September 11th event. And why one would exclude, when the commercial market is going to be picking up and adjusting these claims, and they have had to adjust these claims, if it is straight fire they will have to adjust it, if it is a fire caused by terrorism, they would have the same adjustment issue. The markets will not provide coverage for a terrorist event for business interruption if it is not covered for property damage in the first place. Markets almost never cover business interruption in isolation to property damage.

    So I was not aware that there was a disconnect here on business interruption. But that just puts it back. There will be no coverage for this come January 1 with businesses if that is the case. Seems to me as far as the timing, it is fairly straightforward. If the current environment doesn't change, this risk is going to be 100 percent uninsurable in the commercial market.
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    What the Government is trying to do obviously is change that environment and cure this problem so we get back to some normalcy the way we were before September 11th. I am not saying it is going to be exactly the same, but at some point that has got to be our hope. I don't know whether that is in 2 years, 3 years or 6 years. I think it is something that one has to look at. And as soon as normalcy starts to come back, you will see the commercial market come back to this arena. That is why the Administration's plan does allow for that. And I think that will happen as long as we find some way to cure the environment.

    I will just finish with one other comment. In 1993, we had the first terrorist attack on the World Trade Center. We had offices in that building at that time. Fortunately, we had no loss of life. That is most important. Second, the amount of the insurance claim that we had resulting from that loss was less than $5 million. So as a result of that particular incident, you didn't hear anything about the commercial insurance market saying it needed help that you are hearing now.

    On September 11th, my firm lost almost 300 people in the World Trade Center. Obviously, that is the biggest loss that we have ever sustained. And it is something that my colleagues carry around in the halls and will for a long time. But secondarily, we will also have an insurance claim to present not of a few million, but in the hundreds of millions of dollars. And we just have an office occupancy.

    Mr. BACHUS. Hundreds of millions?

    Mr. SINNOTT. Hundreds of millions of dollars. That is the difference. That is what has happened. I don't see any way for us to get terrorism coverage—and we are starting on our renewals right now with our clients—if some mechanism isn't coming up for sharing the risk, even on a temporary basis between the Government and the private industry, we have got a train wreck coming January 1 in the property area.
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    Somebody mentioned the aspect of life insurance. I don't believe that withdrawal of coverage in the life insurance field is an issue, although I would defer maybe to Constantinos and Dave who are in that business.

    Chairman BAKER. We are told it is not now. Or if you look at it from that perspective, the life industry pays 5,000 claims a day. So even this incident will not be significant for them. Because you take the U.S. population, 275 million people, if you say the average——

    Mr. IORDANOU. 7,000. And most of them that have that understanding, so that industry covers it. It is not an unusual and extraordinary event for them. Yes, it is dramatic based on the way it happened, but not a big event for the life insurance business.

    Chairman BAKER. Thank you, sir.

    Mr. BACHUS. Just to clarify, again, we don't have the text of any legislation. It is in appropriations.

    Chairman BAKER. All we have is a recommendation.

    Mr. BACHUS. The approach says that business interruption is not a big deal.

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    Chairman BAKER. I would like to recognize Mr. Roy Williams, director of aviation, Louis Armstrong New Orleans International Airport, with which I am greatly familiar. Welcome.


    Mr. WILLIAMS. Thank you, Mr. Chairman. Mr. Bachus, Members of the subcommittee. And I am sure you are only familiar with it because you fly over it after you have left out of Baton Rouge Airport. But I am very happy to be here today, although I do feel I am a bit like a fish out of water with this panel that you have assembled here with you. Perhaps the airport experience that we are experiencing today gives some credence to the discussion of what may happen to other industries in the coming months.

    Let me begin with a little background. Armstrong International has 16 passenger carriers and five air cargo carriers, and we just celebrated serving more than 10 million passengers in one 12-month period, an all-time record for the airport. That ranks us as 39th in the United States. There is nothing particularly unique in the airport in terms of insurance risks. It doesn't have any reservation centers, it is not a hub for a passenger cargo carrier. So I think we are sort of a normal example of an airport.

    Prior to the events of September 11th, airports usually had substantial levels of war and terrorism risk included as part of their general airport liability coverage. In our case, $300 million and sometimes up to $1 billion at large hub airports. To date, since September 11th, only 2 insurers have come back into the market with a product that is very expensive and has a very limited and inadequate liability cap of $50 million. At least one of the available policies contains massive exclusions such as not covering screening, baggage and security functions. In addition, these policies include a 7-day cancellation clause.
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    So turning specifically to Armstrong International, for the 12 months which ended September 30th, 2001, our policies covered essentially all risks, including war and terrorism, up to $300 million. Our annual premium was $321,000.

    We had already begun a search for a new policy before September 11th, and in fact, after September 20th we did have an offer of a policy. But the new policy excluded war and terrorism completely. It excluded certain officer and director coverage, and was at a price of $520,000 per year for the same $300 million coverage.

    A short while later, we received an offer of $50 million in terrorism coverage for a $450,000 premium. Thankfully, we received a second offer for the same level of coverage, $50 million for a premium of just over $300,000. And we have bound those coverages. So right now we are now at about $900,000 in insurance costs for much less coverage than we had before at $321,000.

    Now, just this week, we received an additional option to consider, and that is an offer of an additional $100 million in war and terrorism coverage which would increase our total protection to $150 million, half of what we had before. The premium on that additional coverage is $573,000 a year. So put simply, if we accept that coverage, we would have half of our prior war and terrorism coverage, essentially all of our other coverage as we had before for a total annual premium of nearly 5 times what the airport paid last year. About $1.4 million versus $321,000.

    And the important point in this is who pays for this? In terms of our agreement with the airlines, we pass costs such as this directly to the air carriers in their rents and landing fees. That $1.1 million insurance premium increase that we are facing represents a 3 percent increase in the total air carrier costs to operate at Armstrong. This would raise our landing fee by about 15 cents per thousand pounds. Put another way, it is 22 cents per passenger. Again, this is simply not the same coverage we had before.
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    We really don't recommend that we sustain these risks of insuring ourselves against the risk of terrorism by simply assessing exorbitant costs. We instead recommend the subcommittee consider solutions to spread these risks as broadly as possible, taking into account the fact that the risks associated with an act of terrorism far exceed the economic capacity of any individual airport to sustain or pay.

    For example, one solution might be to extend the current Federal War Risk Insurance Program exclusively to airports. The program now does cover airlines and covers their vendors and agents.

    Looking forward, New Orleans is doing well. We are down only 14 percent from our regular scheduled flights. We appear to be operating at close to 75 percent of our normal traffic. We think these numbers will continue to improve. But we cannot fulfill our obligation to Louisiana unless national air volumes return to normal. We believe that what will get those passengers flying again is to restore confidence in the security of our planes and our airports and provide stability in the marketplace. The insecurity regarding the availability of insurance and the calculation of risks associated with actions of terror creates a background of instability, has wreaked havoc with the traveling public and the insurance industry. Restoring the insurance at reasonable rates should underpin any legislative effort to restore this confidence.

    Chairman BAKER. Thank you, Mr. Williams.

    Next, Ms. Marjorie Nordlinger, Senior Attorney, Office of General Counsel, Nuclear Regulatory Commission. Welcome.
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    Ms. NORDLINGER. I am pleased to be here today to provide information about the unique nontraditional Price-Anderson system referred to so many times today. It has evolved from Congress's initial 1957 enactment of the Price-Anderson Act. I will focus on the development of the functions of the indemnification of public liability compensation. The testimony, of course, relates to the nuclear power reactors regulated by the Nuclear Regulatory Commission. I am not speaking on behalf of DOE's parallel functions.

    The Act addressed an unusual insurance situation which was blocking Congress's aim for the development of the peaceful uses of atomic energy. That situation was one where it was impossible to rule out the potential for an accident. There was little or no experience of the kind Secretary O'Neill described. And the possible costs of damages were uncertain. And thus neither industry nor private insurers could absorb the risk. Congress had two paramount goals in resolving this predicament. One was to make available adequate funds to satisfy public liability claims in a catastrophic nuclear accident, and the other was to permit private sector use of nuclear energy by removing the threat of potentially enormous liability in the event of such an accident.

    The solution combined indemnification with the limit on liability. The solution applied to all reactors as a further condition of licensing. And the licensing process itself provided substantial assurance that each reactor would be designed, built and operated to satisfy high safety standards. Originally, Price-Anderson prescribed that each power reactor licensee had to procure available financial protection, which as a practical matter, meant the purchase of $60 million of commercial insurance, the maximum then available. I might add here that the commercial insurance was itself pooled coverage and that was the only way they could get some companies to stand behind the commitment for funding.
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    That first layer was then followed by indemnification by the United States itself to cover up to $500 million in liability over the amount covered by commercial insurance. And the United States never, on the commercial side, exceeded a $500 million indemnification role.

    Aggregate liability for any single accident is, by statute, limited to the sum of the commercial insurance available and the Government indemnity. As you all perhaps know, the Government has never had to pay any indemnity for a nuclear accident on the commercial side, nuclear power plan. The aggregate liability included the liability of any one who was found liable for any reactor accident with the exception of an accident resulting from an act of war.

    This broad coverage is known as omnibus coverage. The omnibus nature of the coverage was designed to serve many purposes. It was to ensure the availability of funds to compensate for personal injury or damage to property of members of the public, no matter who caused the accident. It was there to permit suppliers and professionals to participate in the industry without fear of liability far out of proportion to any profit they might expect to gain, and it was to make possible efficiencies in the process of presenting, settling and satisfying claims.

    Mechanisms to accomplish these goals were incorporated in insurance contracts and in required agreements of indemnification between the licensee and the United States. The end result benefited the public by channeling all legal claims to the reactor licensee or operator.

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    While the Price-Anderson Act provided that liability was limited, the reports of both Houses on passage noted that if actual damages were to exceed the available funds in commercial insurance coverage and Government indemnity, ''the way was left open for Federal contributions after further congressional consideration.'' This concept present at the outset was later expressly included in the Price-Anderson Act amendment, and is often referred to as a ''third layer of protection.''

    Congress amends the Price-Anderson Act from time to time, always mindful of the delicate balance of obligations between operators at nuclear facilities and the United States Government as indemnitor and as representative of the people.

    The most significant amendments to date were those that effectively remove the United States from its obligation to indemnify commercial power reactors and place the burden on the nuclear power industry. This was accomplished without any substantial alteration of the other elements that characterized the Price-Anderson theme, most particularly, without affecting omnibus coverage and liability limited to the availability of funding. And it was enacted with increased protection for the public.

    The first step in this direction occurred in 1975 when Congress mandated that each commercial power reactor contribute $5 million to a retrospective payment premium pool. This retrospective premium was due if, and only if, there were to be damages for a nuclear accident that exceeded the maximum commercial insurance available. The limit of liability was then $560 million. Government indemnification was phased out in 1982 when the potential pool and available insurance reached that sum.

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    In 1988, Congress increased the potential obligation of each and every reactor in the event of a single accident at any reactor to $63 million. The liability insurance available to comprise the first layer is now $200 million. When that insurance is exhausted, each U.S. reactor licensee must pay into the pool up to $83.9 million as adjusted for inflation, if needed, to cover damages in excess of the sum covered by the commercial insurance. The $83.9 million is payable in annual installments not to exceed $10 million.

    Today, the first layer of commercial insurance and the second layer from the reactor pool together would make available over $9 billion to cover any person or property harm to the public caused by an accident. An early amendment expanded the waivers so that in serious accidents, denominated extraordinary nuclear occurrences by the NRC, the defendants must also waive other defenses. The waivers in sum provide a result in the nature of strict liability where the harmed public need prove only that the accident caused their injury, proof of fault is eliminated.

    The statute excludes coverage of property damage at the reactor site, and there are also provisions covering, among other things, settlements, establishment of a single Federal forum, case management, distribution of funds, criteria for allowing legal costs, and the preparation of reports to Congress in the event there is an expectation liabilities will exceed the available sums.

    Thank you, Mr. Chairman. I welcome your comments and questions.

    Chairman BAKER. Thank you.

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    Our final panelist this afternoon, Mr. Richard Hillman, Director of Financial Markets and Community Investment with GAO. Welcome, sir.


    Mr. HILLMAN. In the interest of time, I will be very brief. At your request, our testimony today outlined features of selected insurance programs covering terrorists and other catastrophic events ranking from programs completely controlled and managed by the Federal Government or other governments to programs with little or no explicit Government involvement. Sandwiched in between was a wide range of programs that the public and private sector shared risks together and in varying and different ways.

    The second point of my testimony provided information on alternative mechanisms for funding insureds also including both pre-and post-funding mechanisms and the use of industry pools to share risk.

    Finally, our last point provided some of our own thoughts about how the Congress ought to be approaching next steps. Most importantly we are hopeful that what we are seeing before us is a temporary market failure. And in that vein, we are hopeful that the program that would be designed would not displace the private market. Rather, it should create an environment in which the private market can displace the Government program.

    In summary, we have provided a great deal of information on Federal and international programs to your staffs. And we stand ready to provide any additional information on these programs should you so desire.
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    Chairman BAKER. Thank you very much. We appreciate your attendance and your brevity.

    Let me suggest, Mr. Chairman, that since it is just the three of us and likely to be the only three of us that rather than just proceed with 5 minutes apiece, that we take advantage of a group discussion which would be a little more beneficial, I think and just dispense with the normal 5-minute rule and just jump in when you like.

    We know that we have to do something. We are not sure what that something is. But providing liquidity to the markets at some point with some limit—because like the shareholders of insurance companies who don't and will not tolerate unlimited exposure, neither will our shareholders. So the meeting, I think, needs to be around perhaps a two-step approach, something immediate and short term that would buy us time to do the long-term resolution that might be more appropriate. Is that something—just that protocol from an industry perspective, say we are going to do X and then come back next spring and address the remaining issues, let's assume the short-term program is a 12- or 15-month short-term solution, is that enough comfort for the reinsurance markets to function, given that we are going to come back with a longer term resolution when we have the appropriate time to construct it? Is that acceptable?

    Mr. MATHIS. Can I take the first crack at that? I think that several issues are associated with that. One, the reinsurance market isn't going to function. It is my hope and belief that they may function if there is a viable limit out there in the market. But there isn't any associated with that.

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    Mr. OXLEY. That wouldn't be right away.

    Mr. MATHIS. No, it would be a matter of time associated with that. Second, that was the reason why there was an industry mechanism associated with a pool to try to spread the risk in that area, which could work in the retention area. The problem associated with big net retentions against the industry, and I understand that, in Government, is that it doesn't deal with the individual risk exposure. So therefore, individual companies still have to underwrite against the collective loss that they feel that they might have on an individual risk exposure. And I would predict that, even though a top level measurement on the top part of the Government would certainly bring some measure of comfort and stability back into the marketplace, it wouldn't solve it all unless there was some solution to that mechanism.

    And third, if the Government comes up with something that is associated with a short term timeframe stopgap that isn't consistent over a period of time, you have to recognize that we write policies that have a 1-year policy limit. So if you have that, you have a net retention that is going to move next year to a much higher number, then you have to write the business understanding that that is what your net retention is.

    Chairman BAKER. But that is a problem with even the 3-year program. Because there are projects that are going to take longer.

    Mr. MATHIS. The industry or the current Administration proposal talks about a plan that is 80/20 to begin with and moves to 50/50 in the second year then to higher retention. I think that that is a problem for the industry to not have something that is consistent all the way across to look at and try to quantify and measure because, you know, one month after January 1st, you are writing into the next year.
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    Mr. SINNOTT. I think if you did it on a risk attachment basis, which is the normal way of doing things, since it will be the commercial insurance policy there that will adjust the claim, the Government will have to agree that the cause was terrorism, but if it is on a risk-attaching basis, it is during that policy year, it follows that policy. And if that acceptance happens to extend out over a period of years, it still goes back to that period. That is the way the insurance mechanism works. As long as it follows that, I don't see a problem.

    Mr. IORDANOU. If there was no sunset provision. But you are postponing the issue, because at the end of the day you have to revisit it.

    Chairman BAKER. We are understanding what we are doing is not final. We need more time to examine, study and understand. What I fear is we act precipitously in the next 3 weeks not fully understanding what we are doing, and find out that we have represented to the industry a 3- or 4- or 5-year program that is fatally flawed. That, to me, is a great disservice as opposed to a short term, publicly acknowledged, this is to get us by January 1, guys, and by March or April of next year, we will have an ample opportunity to thoroughly vet it. I wanted to know if there was a visceral no to that. But it may be with certain conditions.

    Mr. IORDANOU. Let me jump in on a couple of our issues.

    Mr. OXLEY. Let me back up. What is the biggest down argument against what Chairman Baker was talking about? What is the worst-case scenario if we were to do that? Is it that there is no longer the political will to fix the problem entirely?

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    Mr. SINNOTT. Really, the issue comes down to what is the sharing between the private industry and this mechanism. As long as that is basically agreed.

    Chairman BAKER. For purposes of discussion, let's just take the President's first year of his plan and just say year one, here is the deal.

    Mr. SINNOTT. If the industry and the insurers can live with that, and if the brokers and others, Dave, can go out now that it is only a 20 percent issue rather than 100 percent withdrawal from the market, I think there is an opportunity to start the market moving along to maybe provide some protection for that 20 percent.

    Mr. OXLEY. The subcommittee will have some evidence by then as to what is happening in the marketplace?

    Mr. SINNOTT. I think getting through January 1 is a big issue.

    Mr. IORDANOU. You are talking——

    Mr. OXLEY. The policy being renewed for another year?

    Mr. SINNOTT. Yes.

    Mr. IORDANOU. Or maybe more. On the risk attachment basis, if any of you own a 3-year policy for a project a construction project, that it will take 26 months or 27 months, if the risk attachment is there, then the coverage will follow throughout that period.
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    Mr. SINNOTT. It is the only logical way to do it. The 20 percent that the private industry has, that is the way the commercial market will look at the claim. It is on a risk attaching basis, even if it is a construction project that runs out. There is nothing unique about that. That is the way the mechanism works.

    Mr. IORDANOU. There is another issue here that I think is grossly misunderstood about how the mechanisms in the industry work. Even I was surprised to hear the comments by my colleagues from academia that were opposed to the first dollar sharing of risk. I will agree that $5- or $10- or $15 billion in the aggregate is a size of risk that the industry can handle collectively. But the way contracts are issued, unless you create within that mechanism an invented sharing, it is not going to work in the marketplace; because at the end of the day, who does provide the insurance for the factory that has the 10,000 employees or assembly plant that might be the next attack?

    Now, even though the industry loss might be $5 billion, not significant, it is only covered by one insurer, and that insurer is out of business. Because if it was Kemper or if it was Zurich in North America, with $4 billion committed to North America, we would be out of business. And that is the part that is being misunderstood in the debate today. That we have not only an issue with aggregation of small risk, but we have an issue in the way the mechanism works today in the private market by instructing the insurance component that allows spreading of risk to operate efficiently.

    And focusing on $5-, $10-, $15-billion in the aggregate, it is significant, but not catastrophic, but it could be catastrophic to a single insurer.
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    Chairman BAKER. What has bothered me in the interface between the Government and the industry in the proposal is the direct providers of the policy to the insured property as opposed to the commercial reinsurance industry. Everybody that I have heard express concern about exposure goes to dense projects where you have high value, high numbers of people in small areas, not necessarily to cattle operations in Wyoming. And in order to not create more of a hazard, we need for insureds to take appropriate self-protecting actions.

    Since the commercial reinsurance guys set the underwriting standards, doesn't it make some business sense for us to enter into our agreement for the backstop with the commercial reinsurers, and then have them set the new security measures or standards in a private market context, but ensure that they do provide coverage for terrorism?

    Mr. BACHUS. I think actually what has been also discussed is the State-chartered reinsurance. They would then—in turn the Government would come in and——

    Mr. MATHIS. The pool.

    Mr. IORDANOU. Independent of how you do it, Chairman Baker, there is no opposition if it is insurance or reinsurance. The principle is the ability to share risk. But that is how you allow the free mechanism, you know, the freedom to go out and write these very large limit policies for the airport or for the water supply company or for the train station or for the stadium. Because at the end of the day, they know that if an event happens, you know that risk will be spread.
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    Chairman BAKER. The insurance company has to lay it off to the reinsurer. The reinsurer is going to lay it off to the Federal Government. All I am saying is from an operations standpoint, when your customer makes the claim and you have to fill out the form the Federal Government prescribes and send it to the Secretary of the Treasury for him to issue a check, I suspect for 2,300 companies and thousands of claims, you are going to have a long wait.

    I would rather, as much as it is practicable, have you engage, turn it around as a business matter and ask a reinsurance company for their appropriate contribution and have the reinsurers dealing with the Department of the Treasury. It seems to me to be a more efficient mechanism.

    Mr. SINNOTT. I hope no one is envisioning that we had a frequency problem. It is a severity issue. If you had a frequency problem, you are 100 percent right. But we are talking severity, which means very few; hopefully no events, but at the worst severity of events. They will be severe in nature. And that can be managed this way. That is the other reason why we advise our clients to take deductibles. Don't do first dollar. But in this case, with the few events—or hopefully none—but the few events that could occur, it is not really first dollar. The industry is going to be in there, because if you get an event, it is likely to be a major event. So the whole idea of first dollar doesn't ring with me on this. I don't view this as really first dollar, because we are talking catastrophic risk.

    Mr. BACHUS. What about a special State-chartered reinsurance company?
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    Mr. CUMMINGS. I am really against setting up that. I think the market works more efficiently in terms of reinsurance contracts. I think that's what we see in commercial markets. It is fairly like financial.

    Mr. BACHUS. You wouldn't have to. They could see——

    Mr. MATHIS. The industry proposal. Not that it could pick and choose individual risk.

    Mr. BACHUS. It is an option you can cede risk to. The reinsurance company, the Government would then participate.

    Mr. HARRINGTON. Then you have the Government in pricing. You should avoid the Government in pricing. If you go down that route——

    Mr. BACHUS. Don't you do that on other——

    Mr. MATHIS. Supporting a funding of the first $10 billion of losses that has built up over a period of time.

    Mr. BACHUS. You actually said that you thought there ought to be a first dollar.

    Mr. IORDANOU. You oppose that.
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    Mr. HARRINGTON. I have assumed that given what I know about the sophistication of reinsurers, if there was a $5- or $10-billion attachment point, there are a lot of smart people in this business that would start thinking about how they could design property treaties so they could price it in recognition that there was a relatively low probability that there will be an amount greater than that amount. Maybe I have grossly overestimated sophistication in the reinsurance markets. But the latest contracts are set up, it has got to attach an 80/20 basis in the first dollar.

    Mr. IORDANOU. There is no way to spread the risk on a catastrophic event. The concept of an industry aggregate of $5 or $10 billion and then something that attaches on the next system, it creates an environment that singular insurers will be exposing up to 100 percent of their capital to an acceptable risk. For that reason, you are defeating the purpose of trying to create liquidity.

    Mr. HARRINGTON. I thought you could deal—you and your reinsurance friends could get together and negotiate this.

    Mr. IORDANOU. It needs to be part of this proposal. If that happens and there is some encouragement either with tax, which I think is a great idea, the reason we are exploring more coverage to foreign markets today in the United States is because we have a bias against the mechanism of setting the reserves for events that we know that will happen once every 10 years, once every 25 years, once every 50 years. Today it is tax efficient for me as a buyer to send my dollars for reinsurance to Bermuda and get a deduction as a business expense, it is a cost of doing business, versus putting it in a tax-free pool.
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    Chairman BAKER. Let's go right to that point. We had the discussion earlier. If you were to create a tax-free pool for terrorism reserves only—and that is a reserve which does not exist—therefore I would argue has no budget implications, but that is a thin argument, what would that do for you in your perspective in enabling you to insure against terrorist risk?

    Mr. IORDANOU. Over time—not immediately, over time as that builds up, it will create more and more capacity in an ability for companies——

    Chairman BAKER. Are you talking 2 or 3 years?

    Mr. IORDANOU. It depends on the size of how much would allow it to—because you got to have some—there is not going to be an open-ended ability to set terrorist reserves, you know, for risk. There has got to be some parameters; otherwise you will eliminate paying any taxes, continue putting up reserves and earmarking them.

    Chairman BAKER. But from an industry perspective, that is a major element in the long-term private market resolution of this problem.

    Mr. IORDANOU. I agree.

    Chairman BAKER. Doesn't help us January 1.

    Mr. KEATING. If we don't think about the long term, we are not going to get there. We will wind up having more of this.
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    Mr. SINNOTT. I think that is right. As I say, we do not have much time to figure out what we are going to do for January 1.

    Chairman BAKER. Let's jump on that, if I may. If we take the President's first year proposal, what additions or modifications would this group suggest to make it a workable plan for, say, 15 months?

    Mr. KEATING. Could I say something? I really don't think it makes sense that the Treasury do first dollar, because the assumption here is that anything that happens is going to be a catastrophic event. Just because they were so clever the first time around doesn't mean every event is going to be a huge event. I don't see the need for the Treasury to step in on everything that might be considered a terrorist act. So first dollar coverage to me makes absolutely no sense.

    Mr. OXLEY. There ought to be a deductible.

    Mr. SINNOTT. You are complicating it, because now you are trying to aggregate the industry together. You are getting into a very complex mechanism. If you keep it simple, it is a co-insurance, policy by policy by policy. Now, that is, you could view that as interim. But otherwise, you figure out an event occurs and you have many insurance companies; how do you allocate it? Who gets the benefit? It becomes more complicated.

    Mr. IORDANOU. Worse than that, you get two insurance companies, both of them out of business.
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    Mr. SINNOTT. So you have to keep it simple starting out, although these points, looking at taxes, are clearly good; you know, the near-term/long-term things that can be done. The other thing that as I said before, I mean I don't know why the mechanism would not include business interruption. It will create another disconnect between the 0 percent that the commercial market is offering and the 80 percent, if that is the number that the Federal program provides. Because these are programs that are together. Most businesses buy property damage and business interruption.

    Mr. IORDANOU. Let me give you the statistics. The business interruption component of loss arising out of covered perils is 50 percent of the loss. So for every dollar of indemnity we give to a customer, 50 cents goes to rebuild the factory and 50 cents goes to reimburse them for business interruption.

    Mr. KEATING. But not everybody buys business interruption.

    Mr. IORDANOU. There is no commercial enterprise that I know that has no business interruption coverage.

    Mr. SINNOTT. Wait a second. Let me tell you. We have experience on this. We do the Fortune 500. I can tell you that there is only a handful, relatively speaking, of the very largest companies that don't buy business interruption. . You are talking about Fortune 500.

    Mr. HARRINGTON. There are lots of things that are on business interruption.
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    Mr. IORDANOU. The business interruption provided by the insurance industry is business interruption arising out of covered perils, so you have to have an incident.

    Mr. SINNOTT. Of your actual lost loss.

    Mr. OXLEY. Mr. Hillman has been studying this at GAO. What is your cut on these different proposals?

    Mr. HILLMAN. I find some of the remarks that these gentlemen are making to be very useful. One of the points that I think may be worth considering is rather than coming up with a $5 billion, a $10 billion, a $15 billion retention for the industry as a whole, because that provides a lot of complicating factors, one thing you may wish to consider is establishing a per-claim limit. And perhaps I will have Mr. Cluff provide that.

    Mr. CLUFF. Either per claim or per insurer.

    Chairman BAKER. For the record, give your name.

    Mr. CLUFF. Lawrence Cluff with the U.S. General Accounting Office. But either way, you avoid the problem of trying to aggregate to some $5 billion, $10 billion, you avoid the pricing problem, and you also avoid the Treasury having to write a check for every little thing that happens. If you have a retention on a per-claim or a per-insurer basis, that solves a lot of those problems.
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    Chairman BAKER. Any reaction?

    Mr. MATHIS. Well the 80/20 is a retention per claim.

    Mr. SINNOTT. That does eliminate the problem that I was saying. It is specific.

    Mr. KEATING. That is fine with me; but going on each claim, each first dollar doesn't make any sense.

    Mr. CLUFF. I concur.

    Mr. IORDANOU. There is no first dollar coverage to begin with in the business. First dollar coverage is for your homeowners. When you get into the commercial business, a lot of our clients will retain maybe $100,000, $500,000, $1 million, some of them $5 to $10 million over the first dollar coverage. They buy beyond that. So in those parameters, I think everything is workable. I don't think it is a bad idea. I think it needs to be on the table. As a company we will not be opposed to it.

    Mr. SINNOTT. It just gets back to what the retention tolerance is of the industry. Fine. They take the first X amount, then they know that they are also going to have 80 percent. It is a matter of figuring out what the retention tolerance of the private industry is, and the willingness of the Government; and hopefully those two things on a temporary basis will match, so that we get beyond this particular real problem that we have and have more time.
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    And the brokers can help in this. There are already small bits of capacity that are being developed. The problem is it is just too big a gap that we are looking at, and we are looking at 100 percent withdrawal. If this was just 10 percent, it would be different, like when some markets decided to get out of the business when we went through this 16 years ago. We were able to deal with it without asking the Government to step in, and we were able to get policyholder investment, and we got it done, and the market returned to normal.

    I think the same thing can happen here, though there is one difference. We didn't have an environmental issue 15 years ago that had to be changed, that we had to find a solution for. In our case, I can tell you that our midtown office, which is where our headquarters is, security is on the top of our list of priorities. I think the comments about this being a free ride for businesses is innacurate.

    Mr. BACHUS. What about the comment, I thought you said, that would increase the risk when the Government steps in?

    Mr. IORDANOU. We totally disagree.

    Mr. SINNOTT. The insurance was there before. We are talking about the withdrawal of insurance. Let's continue to provide insurance which is a social instrument, continuing to provide it on a temporary basis, get the Government in there, get it out as quickly as possible and do it on a basis that allows competition, the particular competition that we like to see on behalf of our clients, which is each of the markets doing its own thing.

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    Chairman BAKER. Let me jump in.

    Mr. HARRINGTON. Temporary, that is fine. But over the long term, it will be a good idea to have some relocation of certain businesses, to spread the risk out to reduce the risk of a big event in a particular place. In the long term, if we intervene we are going to discourage those type of responses.

    Mr. SINNOTT. We are looking at it ourselves because we have 5,500 people in New York City in one big building. I mean, forget about whether or not we have insurance. We are looking at lives here, whether or not there is business disruption. Regardless of the insurance response, we had business disruption. If we have our risks better spread, we will have less business disruption and we lessen the risk to our colleagues. So all of those things are ongoing right now.

    Chairman BAKER. Our position is not to——

    Mr. BACHUS. Can we get into some of the finer points?

    Chairman BAKER. Let me jump one more thing before you do that. As to the element of why there is the pushback on the structure either to the industry or the Administration proposal from some unidentified Members of Congress, you are going through this self-assessment of how do we protect our people, how do we ensure our business exists? But the resolution of that is to ask people with the checkbook or the money, without the people who are going to write that check knowing anything, with the industry, the solvency of the companies to whom we are extending the credit, the limit of our exposure if, God forbid, this thing does turn out to be frequent and large. What we are tying to say, we understand the importance of acting timely and responsibly, but we have to take risk aversion steps ourselves.
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    So that is what we are looking for here. If we can do that with something temporary and come back and not have industry claiming that Congress has not met its obligations because it has not met final resolution, and do that next year, we can have more of these and really get down to the fine points that Mr. Bachus and others would choose to pursue.

    Only to that end in looking at the Administration proposal, pro and con, all the ideas possible are about how we tweak the first-year methodology to potentially be a short-term remedy to give us the long-term critical analysis. None of you gentlemen would invest large sums of money without relying on a great deal of examination by the best staff you could find to give you all the pros and cons. That is where at least I am speaking for myself. I don't feel I am competent to make this decision this afternoon. I may not be competent to make it next year, according to some people. But I think I want to give myself the best shot. So that is where I am.

    Mr. BACHUS. Adverse risk selection. I ask this question: Should an insurance company eligibility for the program be conditioned on providing terrorist risk insurance in all its P and C policies?

    Mr. MATHIS. To a large degree, it already is.

    Mr. SINNOTT. The large commercial markets file and use, where you don't have to get State agreement.

    Mr. BACHUS. But what I am saying, again, should one of the policies of this Congress be that we would require them to offer it?
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    Mr. MATHIS. Well, I have two questions which are associated with that. Are you going to agree that there is a rate preemption and that people can charge whatever rates they choose in the marketplace? The other is that you clearly wouldn't expect that every company would want to underwrite every risk.

    Mr. IORDANOU. In order to eliminate the moral hazard, it has to put the pressure on the management of that company to deal with the kind of risk that would be criticized today in this area that maybe the industry is not paying much attention to.

    And the second point is that, in our view, risk management for terrorism risk, the only authority who can do the best risk management is the U.S. military and the CIA and the FBI and the Federal Government. At the end of the day—that is why we have this event today. In 1993, in 1993 we knew we had a terrorist attack. In 1993 we knew it was the same set of buildings. In 1998 the industry suffered about a little over $1 billion in claims. And we were down in Washington looking, because actual mechanisms of the industry dealt with it.

    Today, just for the record on the perspective that we are talking about, the property casualty business has a revenue of $155 billion. When you look at the equity capital of the industry supporting the $155 billion, it is anywhere from $80 to $100 billion. In one event, almost 50 percent of that capital has appeared. So now you face executives that say they are providing that liquidity in the marketplace. They say if they have two such events in the next year, you will have no property casualty business. The entire business will vanish.

    Chairman BAKER. That is only the case if we have a significant untoward event in the near term. If we are able to get a few years' grace, the industry can survive. And perhaps with tax incentives for reserves, whatever the necessary steps, we can get there. The short-term question is—I think the principal question we have got to resolve today, in the next few days, what do we do about January 1? What does it look like and what are the elements for the taxpayer to make marketplace sense?
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    Mr. BACHUS. Let me ask another. Should the Secretary be given discretion to preempt State regulation?

    Mr. MATHIS. In certain areas. Not total.

    Mr. BACHUS. It will have to happen.

    Mr. SINNOTT. As he says, it will happen in certain cases once you get beyond a certain point where rates are not tariffed. You know, rates are freely negotiated, policy conditions are negotiated. There is not much issue there as far as scope of coverage.

    Mr. MATHIS. Let us take workers' compensation.

    Mr. SINNOTT. Well, that is statutory.

    Mr. MATHIS. And it is State regulated in every State, and there is no ability to deal with——

    Mr. SINNOTT. I was thinking workers' comp. Or what is a terrorist about? If we go to 50 States, we will be in litigation for the next 50 years.

    Chairman BAKER. Some of the things I have read, we are going to be in litigation for the next 50 years.
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    Mr. BACHUS. That is something to give thought to.

    Mr. MATHIS. I want to talk totally about a large—we write a lot of middle-America business. That is in urban areas.

    Mr. BACHUS. OK. Now, this thing includes private passenger automobile coverage. We are talking about 7,000 people die every day. We insure every automobile every day. Should the Government program insure private passenger—isn't there going to be a lot of claims?

    Mr. IORDANOU. Let me give you a scenario and you draw your own conclusion. Most personalized carriers write personal automobile and also write homeowners policies.

    Mr. BACHUS. Homeowners?

    Mr. IORDANOU. Well, if I am in your home and I drink contaminated water, I can have a claim against you, in essence, against your homeowner's, and I can paint a scenario that maybe a water company, their wells get contaminated, and now you have a significant number of homes that have contaminated water through an agent. And we have significant number of——

    Mr. BACHUS. I am just concerned about the volume. If we cover private passenger automobile coverage, the Government proposed it, that is a big volume of claims.
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    Mr. IORDANOU. I can envision private passenger automobile to have a large number of claims.

    Mr. BACHUS. It is in here. Right? What you don't want, you don't want a process in the automobile claim where there is some——

    Mr. SINNOTT. Right.

    Mr. MATHIS. I would say to you, we are in the commercial line. But I don't want to speak for——

    Mr. BACHUS. It is in here right now.

    Chairman BAKER. And I thought we had generally agreement that—because my comments earlier, I was reflecting on commercial reinsurance principally as an interface and commercial lines only being subject to——

    Mr. BACHUS. Well, right now it is commercial property and commercial liability and commercial automobile, workers' compensation, private passenger automobile, homeowners. It does include business interruption, and that is my next question. You know, you are saying that that is——

    Mr. SINNOTT. Sure it is.

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    Mr. BACHUS. It is possible to design a two-tier—what I did here is it is more subjective in figuring out——

    Mr. SINNOTT. Yeah. It is a difficult business interruption adjustment.

    Mr. BACHUS. We just have a different—you know, where we insure 90 percent, you know, and——

    Mr. SINNOTT. We could, but——

    Mr. BACHUS. Could we do 80, 75 percent——

    Mr. SINNOTT. But the adjustment issue is not as straightforward, I grant you, but the World Trade Center claims are going to be adjusted eventually. There are going to be some disputes as respects property damage and also business interruption. There will be a sum total. So the fact that it is more difficult to adjust.

    Mr. BACHUS. You mean to compute what the loss——

    Mr. SINNOTT. Yeah. To calculate what the loss is. I don't see why that would make different treatment from the sharing.

    Mr. BACHUS. It is——

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    Mr. IORDANOU. No. It is——

    Mr. BACHUS. Certainly you are talking about a proposal by the Administration to take care of 50 percent of the profit.

    Mr. SINNOTT. I wasn't aware of that. Was that a recent takeout?

    Chairman BAKER. There are several memoranda characterizing the Administration's proposal. So we don't really have a——

    Mr. SINNOTT. I heard the Secretary, and that was the first I had heard about it.

    Mr. BACHUS. It is in here right now, and what I am saying, it certainly won't take care of the problems of increased premiums, which I agree is not an insurance problem. It is an economic problem. If we are going to have a recovery——

    Mr. IORDANOU. You——

    Mr. BACHUS. We are already in a recessionary situation.

    Mr. SINNOTT. I can almost guarantee that the primary insurance carriers will not cover terrorism on their own for business interruption.

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    Mr. BACHUS. It may be what is done, is that it is an 80/20. Either way.

    Mr. IORDANOU. So there have got to be those mechanisms. But I can tell you the liquidity of the market, working capital and capital for fixed assets will disappear. Why will a bank lend to a restaurant owner if he can't pay the mortgage back because of a business interruption versus a fire?

    Chairman BAKER. Sure.

    Mr. BACHUS. These are little things. You know, you get a package and——

    Mr. KEATING. We have got to be very careful to have the things to protect——

    Chairman BAKER. Well, let me suggest this as a starting point for us, because we have got to do something pretty quickly. Among the respective interests represented here, send us a couple pages apiece on the essential elements you think make short-term sense. Let us not try to fix the world long term. Let us try and get us past January 1, with the understanding that if we can reach an agreement, it would be our obligation to come back to stakeholders next year and do it the right way, but if you really—in my casual observation, where our potential risk is, there aren't many remaining elements that offer all the downside that occurred September 11th, and the likelihood of something of that magnitude occurring in the near term, no one knows.
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    But it would be very difficult, I think, given all the extraordinary measures that have been engaged in, and we certainly can expect, I think, more events, but, you know, hopefully no loss of lives and very little dollar. If we have that luxury and we can do this in a less difficult environment. February, March, I think we can craft a package, hearing everyone's perspective that makes some long-term economic sense, without only debating unnecessarily tax dollars beyond foreseeable vision. And to that end, unless you have got something further, Spencer, I just——

    Mr. BACHUS. Well, we have had mail interruptions here. Does that—if you had a company that had mail interruptions because of an anthrax scare at a local post office, can they make a claim under business——

    Mr. SINNOTT. There has got to be——

    Mr. BACHUS. Or the business has to be shut?

    Mr. SINNOTT. It has got to be damaged from a peril.

    Mr. BACHUS. Mail interruption does——

    Mr. SINNOTT. Sure.

    Mr. IORDANOU. It was the same issue with the Y2K, that there was no business interruption, you know, and there was mitigation around that.
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    Mr. SINNOTT. Remember that we will have, I mentioned, our insured losses. We will have uninsured losses that will be very significant. So insurance——

    Mr. IORDANOU. Professionals that you have——

    Mr. SINNOTT. Insurance only covers generally a relatively small part of what the total loss is.

    Mr. BACHUS. And Mr. Williams, there has been a proposal from this airline security to the airports, and you all write some of that. Be aware that in that bill, the proposal, the standby coverage, extended——

    Mr. WILLIAMS. Yes.

    Mr. BACHUS. We don't know. I am just telling you. They can start fighting and you can start fighting about that.

    Chairman BAKER. Let me express my appreciation to all of you for your long-standing tolerance today. It was a difficult day and we made it and it was helpful to us in getting a better understanding. Thank you very much.

    [Whereupon, at 5:55 p.m., the hearing was adjourned.]