SPEAKERS CONTENTS INSERTS
Page 1 TOP OF DOCHOW MUCH ARE AMERICANS AT RISK
UNTIL CONGRESS PASSES TERRORISM
WEDNESDAY, FEBRUARY 27, 2002
U.S. House of Representatives,
Subcommittee on Oversight and Investigations,
Committee on Financial Services,
The subcommittee met, pursuant to call, at 3:35 p.m. in room 2128, Rayburn House Office Building, Hon. Sue W. Kelly, [chairwoman of the subcommittee], presiding.
Present: Chairwoman Kelly; Representatives Weldon, Biggert, Ney, Tiberi, Gutierrez, Inslee, and Maloney of NY.
Chairwoman KELLY. First of all I want to apologize to all of you for the delay here. There is an unusual floor proceeding going on and I had heard that we had a vote. About 20 minutes ago I heard there was a vote in 5 minutes. And I thought, well, we will just wait that 5 minutes and that would save everybody time.
They are still arguing on the floor. So when they get that argument over, we will go back and we will have to vote during this hearing.
But that being said, I want to thank you all for your patience and this hearing of the Subcommittee on Oversight and Investigations will come to order.
Page 2 PREV PAGE TOP OF DOC
I want to thank all Members of Congress who are present today, and there are a couple in the back room here I think that have come in. Without objection, all Members present will participate fully in the hearing, and all opening statements and questions are made part of the official hearing record.
On September 11th, our world fundamentally changed with the cowardly acts of a handful of terrorists. We all carry with us the memories of the destruction of that day which deprived families of loved ones, people of their jobs, and a Nation of one of its greatest landmarks.
In addition, the losses of September 11th represent the single largest hit to our insurance industry in the history of the United States.
Since then, our insurance markets are facing a new reality. Insurers are being asked to insure terrorism risk when they have no realistic way to determine the fair price for that risk, or in the vast majority of cases, being able to obtain any reinsurance for it.
This risk is one which no one ever anticipated. Moreover, no one can presently calculate the proper odds for where or when the next attack will occur. We do know, however, that our Government officials believe that we should expect additional and costly attacks.
Consequently, the vast majority of insurers have been loathe to cover terrorism, especially for major buildings, factories, or gathering places. Where terrorism insurance is available or is required by law, insurers must charge high premiums for it and offer very limited capacity to protect against the risk of insolvency.
Page 3 PREV PAGE TOP OF DOC
Today, nearly 6 months later, we continue to discover further repercussions from the acts of terror on New York and Washington. One such symptom is the pervasive risk transfer that is currently occurring from reinsurers to insurers of American businesses leaving such businesses vulnerable to future terrorist attacks.
I think the GAO put it best in their report, and I am quoting from that report:
''Since the September 11th attacks, the key dynamic taking place in the insurance industry has been a shifting of the risk for terrorism-related losses from reinsurers to primary insurers and then to the insured. Reinsurers and insurers have begun shedding their exposure to terrorism risk as insurance contracts have come up for renewal, leaving policyholders increasingly exposed to losses from a terrorist attack.''
The GAO goes on to say: ''Large companies, businesses of any size perceived to be in or near a target location, or those with some concentration of personnel or facilities, are unlikely to be able to obtain a meaningful level of terrorism coverage at an economically viable price.''
The focus of the GAO's inquiry was on the availability of property and casualty insurance and reinsurance. That is clearly important. But we also need to consider whether there have been similar detrimental effects with respect to terrorism coverage in the group life insurance area.
Page 4 PREV PAGE TOP OF DOC I hope we can get some enlightenment on that question, as well.
It is clear that the current lack of terrorism coverage acts as a chill factor restraining our economy, which is struggling to recover from recession. Businesses, particularly in cities and near targets, seeking to build are being required to carry terrorism insurance.
However, I am informed that there is little or no terrorism coverage available and hence some new construction is being stopped before it can even start.
This is causing the loss of new jobs at a time when creating jobs should be one of our highest priorities. In short, the Senate's leadership failure to act on terrorism insurance legislation is imposing a fear tax on America, costing real jobs when the country is trying to pull out of a recession.
In addition, since the Administration says that another terrorist attack is extremely likely, we must plan for how the Government should react to such an attack now, not after another attack.
We have learned countless lessons from September 11 on homeland security and distributions from September 11th charities which could have avoided many problems with a little more planning beforehand.
Acting now will preserve a private market mechanism to provide terrorism coverage, capital, and a claims processing system.
Page 5 PREV PAGE TOP OF DOC
Waiting until Americans suffer the next terrorist attack to respond is irresponsible, inefficient, and will ultimately cost the Government much more than taking responsible action now.
Victims will most likely suffer months of additional delays as Congress scrambles to create a bureaucracy to determine which victims get compensated and in what amounts.
This can be especially harmful to small businesses which cannot afford to wait months after a tragedy while Congress decides whether or not and how to respond.
As a former small business owner, this concerns me greatly. Under the leadership of Chairman Oxley, this subcommittee acted quickly last year to pass legislation, H.R. 3210, the Terrorism Risk Protection Act, to protect the U.S. economy, its businesses, and its workers from the negative effects that are materializing today. It is stuck in the Senate.
I sincerely hope that the Senate leadership will act quickly to avoid a potential calamity. Today we will hear from a list of very distinguished witnesses to gain a better understanding of how the lack of Federal legislation has and will affect commercial consumers, builders, lenders, investors, workers, schools, hospitals, public entities, and private institutions.
I would like to thank all of the witnesses for appearing today, and for those of you who submitted written testimony for the record, and for the witnesses who have extra written testimony I thank you for submitting that for the record.
Page 6 PREV PAGE TOP OF DOC
At this time, my good friend from Chicago is on the floor, so I am going to go back to him for his opening statement. But I am going to right now turn to Mr. Tiberi. Have you an opening statement, Mr. Tiberi?
[The prepared statement of Hon. Sue Kelly can be found on page 44 in the appendix.]
Mr. TIBERI. No.
Chairwoman KELLY. Mrs. Biggert.
Mrs. BIGGERT. Thank you very much, Madam Chairwoman, and I appreciate your courtesy for allowing me to attend this hearing.
Madam Chairwoman, January 1st has come and gone and, as predicted, a major change in insurance and reinsurance coverage is taking place that threatens our economy.
Months ago in the wake of 9/11, many Members here predicted what has now in effect occurred. Most reinsurance renewals now exclude coverage for terrorism, and most primary insurers will exclude terrorism coverage in the coming months.
It is because we anticipated this outcome that we on this subcommittee and the Full House acted quickly late last year to pass a terrorism insurance bill. But sadly, our Senate colleagues did not take quick action. They did not take any action before the January 1st renewal deadlines, and not since January 1st.
Page 7 PREV PAGE TOP OF DOC
Unfortunately, as with so many other issues during this Congress, when it comes to terrorism insurance and reinsurance coverage, our colleagues across the Capitol seem to have their heads buried in the sand.
It is my hope that some of our Senate colleagues might be motivated by the comments made this morning by Federal Reserve Chairman Alan Greenspan, who did not mince his words.
He said, quite simply, that passing a terrorism insurance bill is critical to stabilizing the marketplace. Chairman Greenspan is not alone in this view.
Even the General Accounting Office has noted that without a terrorism insurance bill there will continue to be a significant drag on our economy.
Unfortunately, this burden has fallen particularly hard on one segment of the economy that can least afford to live without terrorism coverageour public self-insured risk pools.
These risk pools, more than 125 operating in 41 States, help local governments, school districts, housing authorities, and other public entities to provide necessary insurance protection. They provide coverage to those most often at greatest riskpolice officers, firefighters and emergency medical personnel, as well as teachers and students, municipal employees, and many others.
Page 8 PREV PAGE TOP OF DOC We all know that these public entities cannot absorb the costs of terrorism risk across their membership base. I have heard from several risk pools in my State that are desperate for help.
In Illinois, the Assisted Housing Risk Management Association no longer has coverage for an act of terrorism. That self-insured pool covers public housing authorities across my State.
The Illinois School District Agency, a self-insured risk pool covering public school districts in Illinois, has been told that its July 1st renewal will have a terrorism exclusion.
And the Department of Insurance in Illinois is now allowing the exclusion of terrorism coverage in new and renewable policies.
So my State becomes one of the 45 States that are allowing such exclusions to be written in to policies. The need for Congress to act has never been greater. Large self-insured pools and individual self-insurers such as the City of Chicago will pay as much as four times their expiring premium to buy the additional coverage necessary in the coming year.
Make no mistake, public self-insured risk pools are more vulnerable than other entities. They provide enormous savings to taxpayers. In choosing to do nothing, the Senate threatens to undermine a system that our policemen, firemen, school teachers, tradesmen, assembly line workers, commercial property owners, and others depend on.
Page 9 PREV PAGE TOP OF DOC Without a Federal solution, our workers, businesses, and public institutions will suffer. I hope that the members of this panel will not hesitate to place the blame where it belongs, with the Senate.
I thank you, Madam Chairwoman, and I yield back.
[The prepared statement of Hon. Judy Biggert can be found on page 48 in the appendix.]
Chairwoman KELLY. Thank you, Mrs. Biggert.
We have been joined by Dr. Weldon. Dr. Weldon, do you have an opening statement?
Dr. WELDON. Madam Chairwoman, if I could just for 30 seconds, I want to commend you on this very important hearing and thank all of our witnesses for being here.
I am particularly interested in this issue not only on the merits of the topic being discussed, but as well, the parallels between this issue and natural disaster insurance and the whole reinsurance issue.
I think there is a fair amount of common sense in that. So I am looking forward to hearing the testimony of the witnesses. Thank you.
Chairwoman KELLY. Thank you very much, Dr. Weldon.
Page 10 PREV PAGE TOP OF DOC
Since there are no more opening statements, we will now begin with our witnesses on our first panel.
Before us today we have Mark Warshawsky, the Deputy Assistant Secretary for Economic Policy at the United States Department of the Treasury.
Then we will hear from Richard Hillman, the Director of Financial Markets and Community Investments for the U.S. General Accounting Office.
And finally, we have the Honorable Greg Serio, who is the Superintendent from the great State of New York. He is with the New York State Insurance Department. This is not Mr. Serio's first time before this subcommittee and, Mr. Serio, we welcome you back.
Thank you all for joining us here today to share your thoughts on these issues. Without objection, your written statements will be made part of the record. You will each be recognized for a 5-minute summary of your testimony. There are lights in front of you that will indicate how much time you have. The green light signifies you are in your first 4 minutes. The yellow light will turn on when you have 1 minute left. And the red light will turn on when your time has expired. We hope you will observe the lights.
We will begin with you, Mr. Warshawsky. Thank you.
STATEMENT OF MARK J. WARSHAWSKY, DEPUTY ASSISTANT SECRETARY FOR ECONOMIC POLICY, U.S. DEPARTMENT OF THE TREASURY
Page 11 PREV PAGE TOP OF DOC
Mr. WARSHAWSKY. Thank you. Madam Chairwoman and Members of the subcommittee:
I appreciate the opportunity to present to you the views of the Office of Economic Policy at the Treasury Department on the impacts of the lack of terrorism risk insurance on the American economy.
We appreciate the speedy action of the House in passing legislation last year that would have created a temporary Federal backstop for private insurance.
We look forward to continuing to work with you to restore private insurance coverage for this risk. My testimony is divided into three parts:
The effects of the terrorist attacks on the ability of a business to insure against risk;
The impact on the economy; and
Our need in the face of the continued terror threat to move legislation forward.
The impact of the terror attacks of September 11th and the capacity of insurers and reinsurers has been very large. Insured losses of both primary insurers and of reinsurers over all principal lines of coverage now are estimated to be about $40 billion.
Page 12 PREV PAGE TOP OF DOC
These will be the largest insured losses in history, far surpassing those from Hurricane Andrew in 1992. The capital of the industry was in a sense hit doubly by the attacks. The Stock Market declined sharply following the attacks, reflecting general business uncertainty, and the insurers' investment losses accelerated dramatically as a result, creating the possibility of the failure of insurance companies.
In addition, the attacks revealed to the insurance industry a potential for huge future losses which it had not priced before and cannot yet readily model.
Terrorism risk is not like normal insurance which pools many small risks. It is somewhat more comparable to traumatic natural catastrophes such as hurricanes and earthquakes, but unlike natural catastrophes terrorism risk does not have predictable patterns and probabilities quantifiable by sophisticated models.
As a consequence of their reduced capital base and the inability to model terrorism risk, reinsurers have almost entirely stopped assuming terrorism risk.
Primary insurers which rely on the ability to lay off huge risks to reinsurers are also withdrawing from covering this risk as their contracts expire.
Primary insurers are being allowed by insurance commissioners in all States, with the exceptions of New York, California, and Georgia, to exclude terrorism coverage above certain small dollar amounts from smaller regulated commercial policies in the future.
Page 13 PREV PAGE TOP OF DOC Insurance brokers report that terrorism coverage for large commercial properties whose insurance policies are unregulated is difficult or impossible to obtain. And, when available, subject to the limits of coverage that are much lower than customers need.
And premiums for these properties have increased dramatically. The total policy costs with limited terrorism coverage is reported to be roughly double the cost of a property casualty policy without the terrorism coverage.
These insurance difficulties in turn are affecting the financing of new real estate projects and the sales of existing properties.
Financing is limited for new construction and the acquisition of high-profile properties. Lenders are carefully screening the location and size of buildings. Some are simply refusing to lend to properties that are not fully insured.
Much commercial property development is financed through the sales of securities backed by mortgages on the properties. The securities depend on good ratings from rating agencies to attract investors.
Rating agencies have indicated that they will substantially downgrade new issues of securities backed by mortgages on high-risk properties without adequate insurance coverage.
Those deemed high-risk include trophy assets, symbols of America, structures for large gatherings of people, critical infrastructure, and critical energy providing structures.
Page 14 PREV PAGE TOP OF DOC
The implications of these insurance market conditions and the economic consequences make it critical for Congress to enact a Federal terrorism risk insurance backstop.
The lack of insurance coverage leading to inefficient risk bearing and high premium rates imply a drag on our economy and a burden to the nacient recovery, including the potential for loss of even more jobs.
These costs are like a tax increase on the productive capital, a disincentive to investment, and in the long run a considerable burden for our workers and consumers.
Our enemies have stated that their intent is to cause both economic and physical harm to us. And as the President has warned, our enemies are persistent, clever, and should not be underestimated.
We firmly believe that our Nation's battle against the scourge of terrorism will ultimately be successful, and that private insurance markets will stabilize in the long run.
But we now know how difficult and costly it can be for the economy to adjust to terrorist events. We want to encourage economic growth, and we bear a responsibility for assuring that our citizens are adequately protected against terrorism.
Consequently, we urge that Congress pass a Federal backstop now before the damage caused by lack of terrorism risk insurance takes too great a toll on our recovering economy.
Page 15 PREV PAGE TOP OF DOC
We know that you share with us a clear recognition of the importance of this legislation, and we want to work with you to create the best possible support for our economy and our citizens.
I will be glad to answer any questions.
[The prepared statement of Mark J. Warshawsky can be found on page 51 in the appendix.]
Chairwoman KELLY. Thank you very much, Mr. Warshawsky.
Now we go to Mr. Hillman.
STATEMENT OF RICHARD J. HILLMAN, DIRECTOR, FINANCIAL MARKETS AND COMMUNITY INVESTMENTS, U.S. GENERAL ACCOUNTING OFFICE
Mr. HILLMAN. Thank you, Madam Chairwoman, and Members of the subcommittee:
I am pleased to be here today to present the results of our work on the availability of terrorism insurance in the wake of the tragic events of September 11th.
As you requested, my testimony today describes how in the absence of Federal action insurance companies and the marketplace have reacted to the events of September 11th.
Page 16 PREV PAGE TOP OF DOC
My testimony also provides GAO's initial observations on the potential consequences these market changes may have both in the event of another terrorist attack and, as we all hope, in the absence of one.
On my first point, since the September 11th attacks, the key dynamic taking place in the insurance industry has been a shifting of risk from terrorism-related losses from reinsurers to primary insurers and then to the insured.
The tragic events of September 11th brought to light the huge potential insurance company exposures that they could face in the event of another terrorist attack.
Faced with a continuing uncertainty about the frequency and magnitude of future attacks, and at the same time warnings by Government and military leaders of new attacks to come, both insurers and reinsurers have largely determined that terrorism is not an insurable risk at this time.
As a result, in the closing months of last year reinsurers, followed by direct insurers, began announcing that they could not afford to continue providing coverage for potential terrorism losses.
Because reinsurance markets are global in scope, and because reinsurance transactions are considered to be contracts between sophisticated parties, neither the prices nor the conditions of such coverage are subject to direct regulation.
Page 17 PREV PAGE TOP OF DOC As a result, after September 11th, reinsurers had little difficulty excluding terrorism from coverage. Generally these exclusions became effective on policy renewal dates, many of which were clustered at the beginning of January.
Industry sources confirm that little reinsurance is being written today that includes coverage for terrorism. As reinsurers walk away from terrorism insurance, primary insurers' exposures increase, at least in the short run.
Faced with this kind of exposure and the risks that they do not believe can be priced, industry observers and participants have told us that the primary insurers are beginning to emulate their reinsurance counterparts and exclude terrorism coverage from some commercial insurance policies.
However, a number of factors affect both the speed and the extent to which primary insurers can insulate themselves from terrorism losses. Direct commercial property casualty insurers withdrawal has been slower and less complete than reinsurers because, with the exception of some large risks, direct insurers need regulatory approval to exclude terrorism.
Moreover, there are legal requirements in some States that preclude insurers from excluding terrorism from coverage for Workers Compensation and for fire following an event, irrespective of its cause.
However, the rapid submission of the ISO exclusion language in which the State insurance regulators and the generally rapid positive response by regulators clearly indicate the urgency of primary insurers' desire to be able to exclude terrorism from commercial property casualty insurance coverage.
Page 18 PREV PAGE TOP OF DOC
Over the next year, as insurance policies renew, a growing share will likely exclude coverage for terrorism, absent some intervening factor. Thus, risks that were formerly held by reinsurers and insurers will gradually be shifted back to the policyholders.
Now all policyholders are affected by this shift to the same extent. Indeed, small, low-risk businesses and properties may feel little effect. However, large risks and those where there are factors that give rise to a perception of risk such as location, concentration, or hazardous activity, are experiencing problems obtaining insurance for terrorist events and policyholders are thus bearing more of the risks of loss themselves.
Regarding my second point, the effects of the risk shift from reinsurers and insurers to businesses and property owners can be invited into two parts:
What would happen in the event of another terrorist attack?
And what is happening even in the absence of another attack?
Many of the most severe potential negative consequences resulting from a lack of terrorism insurance coverage will only become evident if another terrorist attack occurs.
The shifting of risk from reinsurers to primary insurers to commercial property holders and other affected parties could place more risks and economic burden on businesses and the public at large should another terrorist attack similar to a September 11th occur.
Page 19 PREV PAGE TOP OF DOC
Consequently, a lack of such coverage in the event of another attack could have more serious effects on businesses as well as their employers, lenders, suppliers, and customers.
Another significant consequence of the insurers exiting the market for terrorism coverage is the loss of their claims handling mechanisms for effectively and efficiently responding to victims of an attack.
However, even in the absence of an actual terrorist event, there are growing indications that some sectors of the economynotably real estate and commercial lendingare beginning to experience difficulties because some properties and businesses are unable to find sufficient terrorism coverage at any price.
Such large property owners or developers reported that they are having to underinsure or go bare by self-insuring for terrorist risk because of the lack of available coverage or very limited coverage for the quoted prices.
Developers, financial institutions, and the insurance industry observers have told us of cases where lenders or investors were reluctant to commit resources to projects that could not be insured against terrorist attacks because they were unwilling to expose themselves to risks that insurers could not price.
In my written statement are examples of these effects and recent news articles have identified still others.
Page 20 PREV PAGE TOP OF DOC
In summary, our Government leaders continue to warn of imminent and credible terrorist threats. Should one of these threats become a reality in a world where insurers ar no longer the first line of protection for businesses, the economic consequences could be very different from those following September 11th.
As businesses both large and small are faced with uninsured losses that threaten their ability to survive, Congress could be faced with a time-critical decision to intervene or not. Deciding whether Congress should act to help businesses obtain insurance against losses caused by terrorism is properly a matter of public policy. The consequences of continued inaction, however, may be real and are potentially large.
Madam Chairwoman, this concludes my prepared statement and I would be happy to respond to any questions.
[The prepared statement of Richard J. Hillman can be found on page 57 in the appendix.]
Chairwoman KELLY. Thank you, very much. As perhaps you see the lights up there, we have been called back not for one vote but, as I understand it, for perhaps a series of votes. Unfortunately, I had intended to start the hearing and let it go right straight through, but if we have a series of votes I am going to be unable to do that because we all have to be on the floor to vote.
So I am going to temporarily recess the hearing for a brief period until the voting is finished on the floor. I am sorry. Procedurally, what is happening on the floor right now is very interesting to people who are students of the Congress, but it is taking your time and I apologize to people who have planes to catch and so forth. We had hoped to get this done in a timely manner. Apparently we are not going to be able to.
Page 21 PREV PAGE TOP OF DOC
So I am temporarily going to recess this hearing. We will come back when the votes have finished. Thank you very much for your patience.
Chairwoman KELLY. This hearing will now resume. Thank you very much for your patience. I apologize for the time.
Let's go now to Mr. Serio.
STATEMENT OF HON. GREGORY V. SERIO, SUPERINTENDENT, NEW YORK STATE INSURANCE DEPARTMENT.
Mr. SERIO. Thank you, Madam Chairwoman. It is a pleasure to be here, and I appreciate the opportunity to give you a sense of what we have seen in the New York market.
As you might say, you can't get any closer than we have been to the situation, and that continues even as the recovery efforts continue at Ground Zero.
I am going to deviate from my prepared oral comments and just give a sense of what we have found. It is very similar to what has been testified to already.
The availability issue is one that we have seen coming for some time. Back in December of 2001, the Insurance Department surveyed the commercial property and casualty business companies writing in New York, and this is what we found:
Page 22 PREV PAGE TOP OF DOC
As far back as December, we knew that 54 percent of the companies writing business in New York planned to reduce coverage limits on both new and renewal business.
We knew that 12 percent planned to materially curtail the number of policies written in certain lines of business. Eleven percent had ceased writing or materially reduced the number of policies written in New York. And 18 percent did so outside of New York as well. So it is not just related to New York.
Twelve percent planned to cease writing or materially reduce the number of policies in New York for 2002, and 24 percent of the companies responding said they planned to reduce their writings outside of New York in 2002 as well.
Eighty-one percent of the insurers responding to our survey are licensed in our Free Trade Zone, which is an area where you can write sophisticated risks free of rate and form regulation, but that they were going to exclude or limit coverage for acts of terrorism. And that 83 percent indicated that their reinsurers excluded or limited coverage for acts of terrorism.
So we knew that. And living in New York, and having our offices just blocks from Ground Zero, we also found by local meetings and public forums that the New York Insurance Department has been undertaking over the last several weeks and will continue to do so, we have found that a lot of what was answered in our surveys in December are coming true now in the market.
Page 23 PREV PAGE TOP OF DOC Our public forums have had one business after the other coming before us, talking about difficulties in gaining coverages, particularly going bare or particular difficulties getting terrorism coverage.
We have met with local business groups. Some of the groups are here today, and you will hear them in the second panel. In speaking with business owners, one on one, and in walking tours that I have done not just in Lower Manhattan but also in Albany, on Long Island, and throughout Upstate New York, we are finding that this is not a New York-centric problem; that it is very much indeed a problem throughout all of New York and, by our numbers, clearly one that is starting to affect other States as well.
The second question that you had in the letter to us inviting us to testify:
What is the impact on the economy?
Well, I can tell you that it hasn't been geographic in nature. It is not sector-oriented. And let me just add one more observation. It is not just limited to businesses. Governments themselves have had tremendous difficulty getting insurance coverages, particularly terrorism coverages, and largely because they are what might be considered to be terrorist risks or targets, but also because, as natural places of assembly for large numbers of people, carriers are reluctant to write Government risks, including public buildings of assembly, bridges, and other types of publicly operated or Government-operated facilities.
The economic viability of the insurance industry to absorb losses, which was the third question in the letter to us, really cuts to the heart of the matter.
Page 24 PREV PAGE TOP OF DOC
That is, that if it is a man-made threat, as the Chair has noted, that the threat of future and different terrorist acts are still with us.
I have as much of a concern over what happens in the court of natural disasters that might come up, and the ability of the industry to weather those storms.
Hurricane season is just 3 months away and is before, by the way, the next largest reinsurance renewal period, and I can tell you that every Gulf State and every State on the East Coast of the United States needs to be concerned about the event of a natural disaster having that second shoe dropping effect on the insurance community in the United States. And that is something that certainly begs the question of some action here in Congress.
Another point I would like to make is that we have been looking at insurance companies not just as insurers and having the capacity to cover risks, but also as participants in the marketplace as businesses, and more importantly as investors in the real estate market in New York and in other large cities.
I can tell you that there is an insurance company that is, or has been known to be the single, or second-largest real property owner in the City of New York. What are the implications, when you consider that those investments that they have serve as the admitted assets of those companies if those assets are now suddenly challenged because they don't have all-risk coverage or go bare for terrorism coverage?
So we have to take a look at that issue, as well.
Page 25 PREV PAGE TOP OF DOC
The Department's response has been, since 9/11, first to deal with the claims' issues at hand; but, second, to get to the question of how do we maintain coverage going forward.
The most profound action that we have taken and one that certainly raised the hackles of certainly the trade press in the insurance community, was to denyand I think I used the termI wasn't inclined to approve terrorism exclusions.
That is because, as I looked outside my window in Lower Manhattan, and also from our perspective around the rest of the State, terrorism coverage, or terrorism exclusions, I should say, that are overly broad simply are in violation of the State law.
They may work for other constituencies in other jurisdictions, and maybe that is one of the beauties of the State-based system of insurance regulation, but for New York terrorism exclusions were not appropriate.
We have pushed back to the companies to give us more definitive exclusions, more narrower language with respect to those exclusions, but I can tell you that at the end of the day we do not want to make businesses and consumers the last stop on the ''Pass-The-Exposure Express.''
And for all of these reasons, we believe that time is now passing for Congress to take action, and we believe that this is nothing new. We are not talking about new ground. But that it is something that, with the examples we have used in the past, either permanent facilities or temporary facilities that we have used in New York in the past, I think we can settle the challenge that is in front of us.
Page 26 PREV PAGE TOP OF DOC
[The prepared statement of Gregory V. Serio can be found on page 77 in the appendix.]
Chairwoman KELLY. We thank you, Mr. Serio.
I am going to ask a couple of questions of you, Mr. Warshawsky. In your written testimony you compare the current economic impact of a lack of adequate terrorism coverage to a tax on productive capital.
I wanted to know if you would elaborate that for us a little bit.
Mr. WARSHAWSKY. Sure. Basically it comes in two mechanisms. The lack of adequate, or any insurance increases the risk exposure of businesses. And as the risks increase, risk has a cost. And the cost is either reflected in increased cost in borrowing, or a decline in equity values, and therefore that sums to an increased cost of capital like a tax on capital.
The other extent to which there is the tax of course is the increase in the premium on any insurance which is purchased. So those two summed together would be considered what I would call quote, unquote, a ''tax'' on productive capital.
Chairwoman KELLY. Thank you. Another question for you.
Page 27 PREV PAGE TOP OF DOC
In your written testimony, you note that those who argue that the lack of a current dramatic impact proves legislation is unnecessary, that they misunderstand the problem.
The witnesses that we have heard today of the three of you seem to agree with that. I would like you to just elaborate a bit on that, too, please.
Mr. WARSHAWSKY. Sure. Basically there are sort of two prongs to that, as well. The most significant one is going forward. That is, that many properties, many businesses and governments as we've just heard are exposed. They are either inadequately insured or not insured at all.
And if there were to be another terrorist attack, then there would be a need to hurry up and devise some other method.
So, you know, that does not speak to the current impact; it speaks to the future impact, which I think is what I was referring to as a misunderstanding of the fundamental problem.
That being said, I think we have found an impact already, an economic impact, as we have discussed both in terms of real estate development and other sectors of the economy, and so I think the impact is there as well.
Chairwoman KELLY. Thank you.
Page 28 PREV PAGE TOP OF DOC Mr. Serio, you categorized the market effect of a lack of available terrorism insurance as a slow death by a thousand cuts. Interesting simile. Rather than a second capitation. And yet, you feel that the Federal Government should act now?
Mr. SERIO. My creativity aside
Mr. SERIO. I have to tell you, what we are really finding in the marketplaceand this has been part of the concern that we have had about the pass-through down to businesses and consumersas much as it has been a challenge to the primary carriers to have them retain the risk for terrorism losses and exposures, it has given us an opportunity to really get our hands around not just the core of the issue, but also how comprehensive the issue is to the overall primary insurance market.
When it comes down and you have the pass-through to individual businesses, it is diluted by each business, as well as by each expiration of coverage and each renewal period, or each renewal cycle for each type of business.
Something we have seen in our Department has been that we have been getting calls, one business, one sector at a time, and it has been difficult to really articulate or to illustrate the burgeoning problem when we have had to do it one sector, one business at a time.
So the primary carriers may feel that they are taking the heat on this, but I think it has really allowed us to illustrate quite clearly what the implications have been arising from the lack of reinsurance for terrorism.
Page 29 PREV PAGE TOP OF DOC
Chairwoman KELLY. The other thing I noticed, you picked a number of different areas, but one that particularly stood out with me was you noted that hospitals are having difficulty in getting adequate terrorism coverage for their facilities.
What happens to these hospitals and their employees if they can't get coverage? And what happens if there is another terrorist attack? We in New York know how very vulnerable we are to something like that, and how might this end up affecting other health care costs in New York?
Mr. SERIO. Actually the hospitals, and I have to appreciate them coming forward, and I know they are here today, they really were the first illustration of a major sector of dysfunction with respect to getting coverage.
They had a renewal cycle back in November, and it has only been recently that we have been starting to look at what is the exponential impact, as you've suggested in the question, and what happens if you have a health care facility that is only covered for a portion of their true liabilities? And given the health care industry in New York where there is a large public/private interplay in the financing of hospitals and health care facilities, you are talking about a broader exposure not just in terms of general health care costs but also in terms of public health care financing as well.
I think the hospital representative can probably better demonstrate that, but that is part of that exponential concern that we have that it will go far beyond just the bricks and mortar of those hospitals to getting into actual health care financing dilemmas and challenges for us if a hospital that is underinsured were to have a loss.
Page 30 PREV PAGE TOP OF DOC
Chairwoman KELLY. Thank you, very much.
My time is up. I am turning now to the Ranking Member, my friend Mr. Gutierrez.
Mr. GUTIERREZ. Chairwoman Kelly, Members of the subcommittee, and distinguished guests, I am pleased that we are holding this important hearing today to discuss an issue that is very present in people's minds since September 11th.
I am sure that all of us in this room let out a collective sigh of relief and joy when the Winter Olympic Games concluded without incident. As our Nation continues to recover from the events of September 11th, I remain confident that the insurance market will also recover.
Nevertheless, and not surprisingly, we all have different views as to how long this recovery is expected to take and how exactly it will happen.
Only last October we heard testimony about the fact that there was great uncertainty as to what would happen if Congress did not act to provide backup for terrorist insurance.
At the time, there was widespread belief that either the industry would experience a devastating setback, or that the potential consequences would at least be severe enough that Congress should worry.
Page 31 PREV PAGE TOP OF DOC
Well, Congress does worry. However, I also understand that the terrorist attacks may have just only begun to effect the market mechanisms to provide terrorism insurance.
While it is reassuring to know that the worst-case scenario did not play out, many answers are still missing. For instance, how much longer before the market corrects itself and the current cycle changes?
What is the cost for this potentially long process?
Has the fact that Congress has not yet provided backup legislation been as detrimental as it was feared in the Fall of 2001?
These are all valid questions that warrant honest answers. Your acceptance to appear before this panel today brings us a step closer in obtaining these answers and expediting a solution to the current problems.
I want to thank our guests for joining us today and I, as always, look forward to all of their testimony.
I would ask the Chairwoman Kelly to provide me an opportunity to put in writing questions to the members that are here before us, and to please excuse me for the remainder of this hearing.
Chairwoman KELLY. Thank you, Mr. Gutierrez, for being here. We understand you have other things that you need, that you must do. And of course, by unanimous consent, we accept your statement for the record.
Page 32 PREV PAGE TOP OF DOC
Dr. WELDON. Thank you, Madam Chairwoman.
Let me begin withit's Warshawsky? Is that correct?
Mr. WARSHAWSKY. Yes.
Dr. WELDON. In your testimony you mentioned the similarity between the losses incurred by acts of terrorism and catastrophic risk like earthquakes and hurricanes. You also mentioned that natural catastrophes have predictable patterns that allow for the assumption and diversification of risk, distinguishing them from terrorism.
However, in my State of Florida and in California, and other States that have had catastrophic risk exposure in recent years, the residential property insurance market seems similar to the recent trends in the terrorism insurance market where high premiums and relatively low coverage is being offered for catastrophic risks.
Could you comment on this, particularly with respect to the premium prices and the capacity of insurers to cover losses?
Mr. WARSHAWSKY. Sure. Basically, as I said, there are similarities and there are also differences between the two types of risk. The similarity obviously is in the, at times, very large losses that could be experienced.
Page 33 PREV PAGE TOP OF DOC
The dissimilarities are twofold. One is that typically we have only experienced the terrorism, major terrorism risk once, but what we saw was there was a majorat the same time, of the insured losses, there was a major decline in investment prices.
That introduced more of a risk to the insurer in terms of, because both risks could happen at the same time. That is less likely to happen because of the more and isolated nature of the natural disasters.
The second difference is, it was my understanding that insurers and reinsurers have devoted a lot of effort and intelligence to trying to find patterns in natural disasters, and I believe that that enables them to more accurately price the risk.
That has been used, I'm told, for example in the issuance of catastrophe bonds that have been used both in California and in Florida. But that has not yet come online. I am not sure if it is able to, but it certainly has not yet come online in this risk.
Dr. WELDON. Do you see a parallel between some of the withdrawal of coverage? There has been withdrawal of coverage in the case of terrorism risk, and there has been some withdrawal of coverage in the case of catastrophic risk. I know in the State of Florida, prior to Andrew, we had 1200 companies offering product. We now have, I believe, less than 200 offering homeowners insurance policies.
Mr. WARSHAWSKY. Well, the comparison there certainly motivated our analysis in terms of viewing this as the likely trajectory of losses in the experience in the insurance market.
Page 34 PREV PAGE TOP OF DOC
So following Hurricane Andrew, the dislocation was 18 months to 3 years, and I think here too that is something you cannot project exactly what would happen, but something like that would be expected here as well.
That is why Treasury proposed, the Administration proposed a temporary insurance backup.
Dr. WELDON. Mr. Hillman, you state that another terrorist attack will place the economic loss on policyholders because insurers have withdrawn or limited their risk to such exposures.
Would you agree that this is the same dynamic that is occurring regarding catastrophic risks from hurricanes and earthquakes?
Mr. HILLMAN. Certainly with terrorism insurance this risk-shifting process that is taking place is much more dramatic than what has been experienced in the past associated with natural disasters for very similar reasons that my friend from Treasury has stated:
That there are opportunities to develop sophisticated modeling methods with which to determine with some predictability the prices for natural catastrophe insurance. That today does not exist for terrorism insurance, and therefore you are finding reinsurers and primary insurers in the industry fleeing from the marketplace.
Page 35 PREV PAGE TOP OF DOC Dr. WELDON. Mr. Serio, I believe you may have commented on this in your opening statement. I got here a little late, but in addition to the exposure to terrorism, New York obviously also experienced some exposure due to catastrophes such as hurricanes. I grew up in New York and I remember some of the hurricanes that came through there.
New York has consolidated its response to these risks in its Emergency Management Office. What have been the impacts of the September 11th attacks on New York's ability to respond or prepare for other disasters such as a natural disaster?
Mr. SERIO. I thinkand getting the Insurance Department more directly involved with the Emergency Management infrastructure I think has given us a new perspective on that very questionI think the direct answer to your question is in how the Emergency Management infrastructure responded to the crash of Flight 587 in the Rockaways just 2 months after the World Trade Center disaster.
I can say that both the State Emergency Management apparatus and the City Emergency Management apparatus, which you may know was destroyed entirely in Building 7 of World Trade, is now up and running in temporary quarters in Brooklyn, but never had there been a default in the interface between the City and State Emergency Managers, and I think that is in large part the reason why the response to World Trade and American Airlines was so good.
And so as we approach hurricane season, I think that the State of New York and its localities are in a good position to respond to a natural disaster.
The industry I think is also in a good position to respond to a natural disaster because of what they learned from World Trade.
Page 36 PREV PAGE TOP OF DOC
I think their concern is certainly more financial than procedural in terms of their ability to get in and to handle a large risk, something in the order of whether it's an Andrew at $19 billion or something like World Trade which is substantially more.
Dr. WELDON. I was very interested in your comments about the nature of the real estate investments for some of the insurance companies.
Do you feel that the reinsurance market as it currently exists today is adequately serving the insurance needs of the major insurers in the City and State of New York?
Mr. SERIO. Up to this point in time, we have not been receiving complaints from the primary insurance market as to the inability or the failure of their reinsurers to pay.
Out of the $15 billion that has either been claimed or paid up to this point, that still has largely come out of the primary carriers, although the reinsurers as their layers start tothe attachment points start to be met, they have been paying them and we have not had any unusual deviations from the normal practice of timely payment of reinsurance recoverables.
So they seem to be doing as well a job in paying their primary carriers as the primary carriers are in paying their insureds and their commercial insureds.
Dr. WELDON. Do either of the other two witnesses want to comment on the status of the reinsurance industry and the impact of this disaster on that? Did you have anything to add to what Mr. Serio said?
Page 37 PREV PAGE TOP OF DOC
Mr. WARSHAWSKY. Nothing to add.
Mr. HILLMAN. Nothing.
Dr. WELDON. Thank you very much, Madam Chairwoman, for this very interesting hearing that we have had.
Chairwoman KELLY. Thank you, Dr. Weldon.
I would like to ask a couple of other questions here. I would like to go on with what Mr. Serio was saying.
Mr. Serio, on page 13 you testified about the dangerous risk shifting to policyholders and the resulting economic drag.
What about the effects on group life and workers compensation markets that are so important for protecting our citizens? And how are those markets now being affected by this situation?
Mr. SERIO. The over-concentration-of-risk issue has really come home to roost in the group life and in the workers compensation area.
We have a situation not just in New York but frankly country-wide where reinsurance for workers compensation has, I think one commentary said, it has evaporated.
Page 38 PREV PAGE TOP OF DOC
There is significant concern for catastrophic reinsurance for workers compensation. Already in New York and in other States the rating services, the New York State Compensation Insurance Rating Board has already approached the Department for an emergency rate increase to cover the catastrophic reinsurance expense that they are incurring right now. We are in discussions with them on that question.
But if it is reinsurance which is not usually part of the rate base for workers compensation, what we may end up with is either a workers compensation environment where if they cannot get adequate recoveries for their rates, they will significantly curtail the writing of workers compensation business.
In turn, the residual markets will once again become primary carriers and the primary writers in those markets, and I do not think that is good for business. And frankly, it is not good for the State that sponsors the residual market.
Chairwoman KELLY. Thank you, very much. It does not paint a very rosy picture.
Mr. Hillman, the GAO report concludes that the potential negative consequences of not having terrorism insurance are cause for concern.
It seems to me like it may be a very nice way of saying we should be concerned. If you say that the consequences of continued inaction may be real and are potentially large, what are the benefits right now of putting in a contingent Federal backstop in place versus the cost of just waiting around until another terrorist attack happens and considering how to respond at that point?
Page 39 PREV PAGE TOP OF DOC
Mr. HILLMAN. The decision rests with the Congress as to whether or not they ought to implement a plan, but there are at least several reasons that I could think of as to why it would be better to act now.
Number one, simply it would be a prudent act to develop a plan when you have the time to develop a plan right. Under a crisis in the event of another attack would not be the right time to be thinking about how to deal with the terrible situation.
Second, you want to keep insurers capital and their claims processing capacity in the game. What we have found from the results of our study is that the claims processing capability of the insurance industry will be quickly evaporating as they insulate themselves from this market.
In the event of another attack, then, it may require the Federal Government to institute new claims' processing capabilities, which is a daunting task.
Finally, acting now would strengthen confidence in all the markets, its participants, lenders, businesses, and insurers, and that could only be good for the economy.
Chairwoman KELLY. Mr. Hillman, do you think that the needand this is not a trick questiondo you think the need for legislation at this point is more about insuring the solvency of the insurance industry? Or more about preventing a risk transfer to the vulnerable policyholders, stopping economic drag, and creating an efficient response mechanism to future terrorist attacks?
Page 40 PREV PAGE TOP OF DOC
Mr. HILLMAN. With this risk shifting that we have been talking about, more risks are first going to be placed off of reinsurers and onto insurers.
In the event of another attack, that could mean then that these primary insurers could have more solvency issues than we have seen in the past.
If an attack would occur later, the insurers themselves would become insulated. And then the problem is going to rest with businesses, and it is going to rest with their employees, their lenders, their suppliers, creating much more economic concern than the major concerns of a September 11th.
Chairwoman KELLY. It sounds as though you are describing, all of you are describing a ripple effect that is gaining with each wave out. Am I correct in that assumption?
Mr. HILLMAN. [Nods in the affirmative.]
Mr. WARSHAWSKY. [Nods in the affirmative.]
Mr. SERIO. [Nods in the affirmative.]
Chairwoman KELLY. You can do something besides nod so we can get this on the record.
Page 41 PREV PAGE TOP OF DOC Mr. HILLMAN. Yes.
Mr. SERIO. Yes.
Mr. WARSHAWSKY. Well, let me do more than nod. Basically sort of the ripple comes in at least two ways. One is, as the insurance contracts expire the lack of terrorism risk insurance becomes more and more widespread.
The second ripple effect is through the investment process. What we have noticed is progressively the rating agencies for, we've focused on commercial-backed, commercial mortgage-backed securities, there is a progressive realization and work in that area, and that is another ripple effect.
I think that can be repeated in other sectors of the economy in other aspects.
Chairwoman KELLY. Thank you, very much.
Mr. SERIO. Yes. If I could just add to that, and this is something that I don't think people are seeing just yet, is the wave or the ripple that comes up. People are concerned about the size of the wave, but I think as Dr. Weldon being from both New York and Florida knows, it is the undertow that is actually more dangerous.
Page 42 PREV PAGE TOP OF DOC
What we are concerned with is not so much the wave as it goes down toward the businesses and the consumers, but what is that backlash, or what is that undertow back from the consumers and the businesses?
That is really where you are going to see the real economic impact if we do not deal with the ripple or the wave as it comes up in the first instance.
Chairwoman KELLY. I want to thank you all. There are no more questions, I don't believeDr. Weldon?
Dr. WELDON. No.
Chairwoman KELLY. I want to note that there are some Members who may have additional questions. They may wish to submit these questions in writing. So without objection, the hearing record will remain open for 30 days for Members to submit written questions to the witnesses and to place their responses in the record.
The first panel is excused with our grateful thanks for your spending so much time. We are greatly appreciative. If the second panel will take their seats at the witness table, I will begin the introductions.
While the second panel is taking their seats, I would like to note that I have written testimony that has been submitted by Edward C. Sullivan, the President of the Building and Construction Trades Department of the AFL-CIO. He says in that testimony that:
Page 43 PREV PAGE TOP OF DOC
''Every day that goes by between now and the time Congress completes action on terrorism insurance legislation presents an increasing threat to our members whose livelihood is dependent upon a robust and healthy atmosphere for building and construction. Every day that goes by without a Federal terrorism insurance law on the books presents a serious and escalating threat to the building and construction industry as a whole, and likely to downstream industries like suppliers. This translates into a threat to our economy and a loss of jobs for our members. A Federal backstop for terrorism insurance can do away with both of these threats, and it is as simple as that.''
We will insert, with unanimous consent, the entire statement of Edward C. Sullivan into the record.
[The prepared statement of Edward C. Sullivan can be found on page 203 in the appendix.]
Chairwoman KELLY. And now I would like to introduce the second panel. For our second panel, we will begin with David Mairam I pronouncing that correctly?
Mr. MAIR. Yes, ma'am.
Chairwoman KELLY. Thank you. David Mair, President of the Risk Insurance Management Society, and Director for Risk Management for the U.S. Olympic Committee.
Next we will listen to Deborah Beck, the Executive Vice President of the Real Estate Board of New York.
Page 44 PREV PAGE TOP OF DOC
Then we will hear from Lisa Kramer, who is the President and CEO of the Federation of Jewish Philanthropies Service Corporation.
Next we will hear from Kieran Quinn, the President and CEO of the Column Financial, Incorporated, a subsidiary of Credit Suisse First Boston.
After Mr. Quinn we will hear from Robert Hunter, the Director of Insurance for the Consumer Federation of America. Mr. Hunter has been before the subcommittee before and we welcome you back, Mr. Hunter.
Finally, we will hear from Alice Schroeder, Senior U.S. Nonlife Equity Insurance Analyst for Morgan Stanley.
I want to thank you all for taking so much time out of your busy schedules to join us here today, and I really appreciate your being here and staying with us for this long period of time that unfortunately this has been that we have had with the floor delay.
So without objection, your written statements will be made part of the record. You will each be recognized in turn for a 5-minute summary of your testimony, and we will begin with you, Mr. Mair.
STATEMENT OF DAVID I. MAIR, PRESIDENT, RISK AND INSURANCE MANAGEMENT SOCIETY, ASSOCIATE DIRECTOR FOR RISK MANAGEMENT, U.S. OLYMPIC COMMITTEE
Page 45 PREV PAGE TOP OF DOC
Mr. MAIR. Thank you, Madam Chairwoman.
As you indicated, my name is David Mair. I am the Director of Risk Management for the United States Olympic Committee, and the President of the Risk and Insurance Management Society.
RIMS is the largest professional organization for risk managers worldwide. Some will come to you, Madam Chairwoman, and suggest to you that they represent the consumers of commercial property and casualty insurance.
I am here today because we are the consumers and appreciate the opportunity to share directly with you our story of what has happened in the months since September 11th.
Insurance is a key part of the infrastructure, the financial infrastructure for business in the United States. It provides the capability to address the costs of unforeseen and unpredictable and preventable events, and it provides coverage for companies both large and small.
There are many in the fall who looked and said: ''This is an insurance industry issue.'' I want to submit to you today that it was not then nor is it now. This is an issue for policyholders.
The buck has now stopped with those consumers of insurance in cities and towns across America. Companies both large and small now assume nearly all of the risk of owning commercial properties and of operating businesses in the United States. These companies are now working and living in a Nation that has been targeted for terror by a most unpredictable type of an enemy.
Page 46 PREV PAGE TOP OF DOC
Some have said to you that this is a very complex situation, and it is, but it is also yet one that I think can be summarized with a fairly simple analogy.
We have been placed on the interstate highway system in our automobiles at highway speed with the protective steel sidebeams having been taken out of our cars and our seat belts taken away.
If nothing happens to us in the United States, we are all going to be fine in this situation. However, if that truck, known as terrorism today, broadsides us in an intersection, the results are going to be devastating.
That is the situation that we are in today in the absence of insurance for terrorism.
In November of 2000, the press was coming to us with the Olympic Games coming up and asking, ''How is this going to impact you?'' I had the luxury, in mid-November, of being able to say to members of the press the United States Olympic Committee is going to be fine. We have policies that expire after the Olympic Games, which have now just concluded. However, at the end of November that situation changed dramatically when one of our carrier's rating was downgraded, forcing us back into the insurance marketplace trying to find general liability coverage for the Olympic team going to the games in Salt Lake City.
The insurance marketplace, at a time it was already concerned about terrorism coverage, looked at the headlines which said ''Olympics'' and ''Security'' in the same banner headlines day after day after day, and they were rightly concerned.
Page 47 PREV PAGE TOP OF DOC
We went 70 days without being able to find coverage, and finally were able to place it on February the 9th, the day of opening ceremonies for the Olympic games.
We were, however, able to place that at 45 percent of our expired limit. We couldn't get any more. We placed it at a 250 percent rate increase without terrorism coverage.
Later that same day, we were able to find stand-alone coverage by going to the same carrier that had been downgraded, which no longer met our requirements, and basically calling in a favor. Because we already had a 3-year guaranteed rate program that simply we couldn't utilize because of the downgrade, nor could we get excess coverage written over the top of that.
We were able to place that terrorism coverage at 5 percent of our expired limit for 100 percent of the expiring premium.
Some will tell you, Madam Chairwoman, Mr. Weldon, that there is coverage available in the marketplace today, and that it may be affordable. Well, in our membership we have 900 companies that represent small businesses, companies with less than 500 employees. They can't take that same rate increase that we incurred only because we were concerned about America's athletes and the interests of America's Olympic teams at the games.
In small businesses, as you know, that comes right off the owner's dining room table. It comes right out of the pockets of their family, their disposable income, and what they can afford to pay their work force.
Page 48 PREV PAGE TOP OF DOC
Is there a drag? Yes. Is it happening slowly? Absolutely. This is a crisis that is happening in slow motion.
My father is a small businessman in Oklahoma. His insurance coverages does not renew until July. He has not seen the impact of this yet. But he will.
Large businesses have been looked at with the comment that there are all kinds of alternative risk financing vehicles that they can utilize, and that is generally true. But those same large vehicles go to the reinsurance community and are buying insurance which is today not available.
It simply cannot be found at any price.
The Congress has had its own experience. When Anthrax was found in the Senate office buildings, that building was closed for a matter of months at a cost of millions of dollars, with the Federal Treasury serving as the backstop.
Imagine what would have happened had that been a mid-sized business somewhere. Without the availability of terrorism insurance, they would have been unable to afford that cost, and they simply would of had to close their doors and go away with a loss of jobs there.
There are some who will tell you that, in an attempt to deflect the focus, this is a simple issue. It's an issue of increased prices. It's an issue of whether or not claims costs from September 11th will be paid.
Page 49 PREV PAGE TOP OF DOC
It is simply not that easy, nor that simple, at one level. More important is whether the terrorism coverage that will exist will be there to respond, and today it simply is not.
I am a risk manager. My job is to identify the causes for loss and prevent them to the greatest degree that I and my colleagues can, in our businesses.
The environment we are in today is similar to looking at a national forest and saying: ''I don't see smoke, therefore there's no fire.'' We should more appropriately be looking to see whether there are unattended campfires ready to catch and set fire to the woods around us. Unfortunately, it is the terrorists lurking in the shadows who hold the matches.
Again, we are in a car on the highway. The steel beams have been taken away from us. We are simply waiting to see, by action of the Congress, by action of the Senate, whether those steel beams will be put back in the car before something happens.
I thank you for the time, and I will appreciate the opportunity to answer questions as you ask them.
[The complete statement of David I. Mair can be found on page XX in the appendix.]
Chairwoman KELLY. Thank you very much, Mr. Mair.
Page 50 PREV PAGE TOP OF DOC Ms. Beck.
STATEMENT OF DEBORAH B. BECK, EXECUTIVE VICE PRESIDENT, REAL ESTATE BOARD OF NEW YORK
Ms. BECK. Chairwoman Kelly, thank you for the opportunity to appear on behalf of the real estate industry.
My association represents over 5,000 owners, builders, institutional owners, and investors, as well as others involved in New York City real estate.
Our members also have interests across the Nation and globally. You may have seen the New York Times piece today, which unfortunately missed the point where terrorism insurance for large commercial properties is concerned.
I am here to confirm that every day without legislative action is putting America's economy further at risk. Lenders demand terrorism coverage for making or renewing large-scale loans. Limited availability is stopping them from doing so.
Investment in real estate is faltering as the risk of loss from terrorism is being transferred from insurers to commercial property owners.
As of January 1st, 70 percent of reinsurance for terrorism ceased. By July 1st, there will be none. Without reinsurance, the primary carriers will not cover terrorism risks for large urban or suburban, or for other properties near what are considered to be terrorism targets.
Page 51 PREV PAGE TOP OF DOC
While lenders insist on full terrorism coverage, only four companies are offering it, limited in the aggregate to $10 billion.
In New York City alone, high-rise office and residential buildings have a replacement cost of $300 billion, not including our valuable religious institutions, universities, hospitals, and the like.
Here are some specifics of pending defaults, stymied sales, stymied refinancings, and deferred construction projects, a direct result of the lack of terrorism coverage. There are more details in my written submission.
A real estate portfolio with property in cities like Chicago, Boston, and New York, and elsewhere, carried blanket coverage of a billion dollars before September 11. Since then, for this owner and in general blanket coverage is no longer available on renewal. Now, the owners are technically in default on their loan.
Owners of a $3 billion mixed portfolio in the Mid-Atlantic and New England States operate by building and then borrowing against completed projects to finance future ones. They cannot get adequate permanent financing on a recently completed fully occupied building because terrorism insurance is not available. The company has 2,000 employees, some of whose jobs are now at risk.
A bank agreed to refinance a $200 million mortgage, but in January suddenly withdrew from the transaction over the terrorism insurance issue just before closing. In this and in another similar case, lenders are stalling by discussing everything but terrorism insurance.
Page 52 PREV PAGE TOP OF DOC
Mortgage brokers we have spoken to assume the lenders want to be ready to lend and hope that Government will resolve the terrorism insurance issue before they must decide whether to commit. An East Coast and Chicago hotel builder with projects averaging $300 million cannot finance without terrorism coverage and so will not start any new construction. Hotel industry unemployment will increase.
Inadequate terrorism coverage may kill the sale of a Times Square building priced at close to $600 million, and the Mall of America is at risk of default because of the terrorism insurance problem.
A major university has no coverage for terrorist incidents involving its laboratories. Its' research may have to be restricted at a potential cost of scientific advances. I add here that any terrorism insurance now written specifically excludes nuclear, chemical, and biological acts, the very type of assaults the public fears the most.
There have been, or soon will be, similar cases in every district represented on this panel. For all its urgency, the lack of terrorism insurance has remained a silent crisis. Owners have not complained publicly because they do not want to frighten the public or their tenants, investors, lenders, and potential purchasers.
In addition, policy renewals are staggered so many pre9/11 policies will remain in effect for several more months. Those covered owners are terribly concerned by the current lack of adequate coverage and hope Congress will address the problem quickly.
Page 53 PREV PAGE TOP OF DOC In summary, these are the grim prospects if steps are not taken:
Sales of high value property will be few. Prices will drop. Property tax assessments and recording sales tax revenues will also drop and localities will face harsh budgetary choices.
I am inserting for the record an analysis by Cushman & Wakefield of likely lost tax revenues for New York City and New York State alone this year if Congress fails to act.
Owners in default will have to renegotiate, pay higher interest rates, and be compelled to take larger equity positions. Owners will not have funds to make needed improvements or do transactions. Construction and rehabilitation work for the trades will fall off. Lenders will loan less, declare owners in default, and maybe foreclose. Bank profits will drop.
The Senate must act on legislation now. Only the Federal Government can provide temporary backup terrorism insurance coverage. This initiative would not be a bailout for the insurance industry, but an effective defense to protect us, your constituents, from the economic aftershock of 9/11.
I would be happy to answer your questions.
[The prepared statement of Deborah B. Beck can be found on page 23 in the appendix.]
Page 54 PREV PAGE TOP OF DOC Chairwoman KELLY. Thank you, Ms. Beck.
We go now to Ms. Kramer.
STATEMENT OF LISA KRAMER, PRESIDENT AND CEO, FEDERATION OF JEWISH PHILANTHROPIES SERVICE CORPORATION
Ms. KRAMER. Thank you. Good afternoon, Chairwoman Kelly, Dr. Weldon, and Members of the subcommittee:
I am the President of FOJP Service Corporation. FOJP is a non-profit membership corporation. We serve as risk management advisors to United Jewish Appeal, Federation of Jewish Philanthropies of New York and its beneficiaries, among which are six major academic medical centers, many long-term care facilities, and 110 social service agencies, community centers, Ys, and camps.
These institutions are at the forefront of providing cutting edge medical care, a broad array of mental health services, cultural, educational, and physical fitness programs, services for the elderly and for immigrants, camping and daycare for the young and the elderly, and employment counseling and training for those seeking jobs.
Services are provided on a non-sectarian basis to a population that reflects the diversity that New York State is known for, and often to people who have nowhere else to turn. Our facilities provide services and health care to millions of people year-in and year-out.
Page 55 PREV PAGE TOP OF DOC
In its capacity as risk management advisor to these institutions, FOJP works with leading insurance brokers to procure lines of property and casualty insurance coverage that are essential to protect the institutions from liabilities and losses.
In May of 2001, through two of the largest insurance brokers in the world, FOJP began the process of marketing the renewal of the all-risk property insurance that covers loss of or damage to the real property of its client institutions, property valued in excess of $8.5 billion.
The renewal date was November 1st, 2001. In July of 2001, each of our brokers was assigned seven of the world's largest and most respected property insurers to which to market FOJP's coverage.
Sealed bids were due on September 17th. The brokers were actively in the process of seeking renewal quotations when the attacks of September 11 took place. An already hardening property casualty insurance market became a nightmare for insurance consumers.
FOJP stopped the competitive bidding process and used one broker to scratch and claw the worldwide insurance market for a renewal program. Before the November 1 renewal, FOJP's clients enjoyed property insurance limits of over $8 billion. Following the November 1 renewal, and despite the extraordinary efforts of one of the world's largest insurance brokers, 16 international insurance companies in combination provided a program with significantly less coverage and dramatically increased costs.
Page 56 PREV PAGE TOP OF DOC Most alarming, however, was that terrorism exclusions were added to the policies. Upstate hospitals, particularly in Buffalo and Albany, have seen their insurance limits drastically reduced, both their deductibles and premiums dramatically increased, and all had terrorism exclusions inserted in their policies as well.
The combination of significantly reduced limits and terrorism exclusions experienced by the FOJP program has become commonplace, posing a serious threat to the ability of non-profit health care and social service institutions to continue to provide the services that are so important to the poor, the aged, the sick, the disabled, and to those of us who are lucky enough to enjoy cultural and educational services without the burden of sickness or disability.
Each of FOJP's largest hospital clients has over $500 million in long-term debt, as well as more than $100 million in short-term loans for new construction. In the event that one single terrorist act even far below the magnitude of September 11 seriously damages or destroys any significant property in the United States, the effects of such a scenario could be far-reaching and devastating.
Lender agencies will realize that they are the insurer of last resort. Institutions will be unable to rebuild because of terrorism exclusions, and there will be defaults to private mortgagees and Government lenders.
Lenders may respond by requiring terrorism coverage before lending any additional money to similar institutions. The institutions will then face the choice of foregoing essential programs necessary to fulfill their mission, or paying exorbitant terrorism premiums for insufficient coverage.
Page 57 PREV PAGE TOP OF DOC
A leading writer of terrorism coverage recently quoted the FOJP program a premium of over $4.2 million for only $50 million in coverage. Premiums of this size are simply not affordable in the current fiscal environment.
Leaving aside the day-to-day financial stress non-profit institutions bear in providing services, basic insurance costs are rising precipitously. There is no money in any budget to pay the premiums that are being quoted for terrorism coverage, if such coverage could be found at all. And even if the money could be found, the limits being offered are seriously inadequate.
If one of our insured hospitals were to be seriously damaged or destroyed by a terrorist act, $50 million in coverage would make but a small dent in the hospital's financial obligations and rebuilding costs.
The issue of insurance coverage for property loss caused by acts of terrorism is a serious one. Coverage is either unavailable or coverage that is available is inadequate in limits and unaffordable in price.
We need Congress to act, and to act quickly. Thank you.
[The prepared statement of Lisa Kramer can be found on page 24 in the appendix.]
Chairwoman KELLY. Thank you, Ms. Kramer.
Page 58 PREV PAGE TOP OF DOC
We move now to Mr. Quinn.
STATEMENT OF KIERAN P. QUINN, PRESIDENT AND CEO, COLUMN FINANCIAL, INC., A SUBSIDIARY OF CREDIT SUISSE FIRST BOSTON
Mr. QUINN. Good afternoon, Madam Chairwoman, and Members of the subcommittee:
I appreciate the opportunity to be here today to discuss terrorism and its effects on the commercial real estate finance industry.
In 2002, Column Financial closed 549 individual loans for a total of $5.8 billion. The smallest loan was about a million dollars. The largest loan was $480 million.
Since 1/1, we have turned down roughly 9 to 10 loans valued at approximately $500 million only because they lacked terrorism insurance. Today we will not consider any loan in excess of $50 million without full terrorism insurance coverage. We will scrutinize all loans in excess of $20 million if they have any terrorism exclusions. And we have been anticipating we will receive all-risk policies on smaller loans. It is early in the year. We have not seen everything yet.
My competitors are also turning down loans because of the lack of terrorism insurance. High risk office buildings in high profile cities such as New York, Washington, Chicago, LA, will be extremely difficult to finance without terrorism insurance.
Page 59 PREV PAGE TOP OF DOC
My fear is if another attack occurs, the insurance markets may shut down. To put the finance industry, the commercial real estate finance industry in perspective, our total outstanding commercial mortgage debt equals $1.7 trillion. Property taxes alone provide almost half of all Government funding, and more than 70 percent of the local tax bases throughout the country.
The real estate industry contributes approximately 11 percent of the Gross Domestic Product. 2001 was a record-setting year for commercial and multi-family loan production. New CMBS totaled over $76 billion in the U.S. alone.
Many of these loans were already in the pipeline before September 11th, but more importantly most lenders and originators continued to lend with the assumption that Congress would act and pass terrorism reinsurance backstop.
Loan production volumes for 2002 will be at risk if terrorism insurance coverage remains unavailable. During 2001, commercial real estate finance activity in Chicago alone was $10 billion. In Los Angeles, it was $10 billion. In New York, it was $12 billion.
This could represent a loss of business for lenders and developers. It could also represent a loss of future construction jobs and a current loss of transfer taxes to the localities.
Furthermore, pension funds and life insurance companies invest directly in commercial real estate as owners, and many of their investors, including average Americans who rely on fixed incomes, will see an industry downturn effect seriously adversely affect their retirement savings.
Page 60 PREV PAGE TOP OF DOC
Currently there is a risk transfer occurring from the insurance industry to commercial business. Forty-six States have approved exclusions for terrorism, war, and military action and the use of nuclear, biological, or chemical material. This risk is being transferred to borrowers and to lenders, thus making the lenders the insurers of last resort.
If this situation remains, lenders will not be able to continue to make loans. I am here to say that lending capacity in 2002 is being dramatically affected by the lack of available terrorism insurance coverage.
My company is not the only lending institution affected. Several Manhattan high rise projects whose collective values equal about a billion dollars have lost funding because terrorism insurance could not be obtained.
Another company has established a policy to exclude funding consideration for all loans excluding $25 million without terrorism insurance. Many servicers of commercial mortgage-backed securities have concerns about insurance coverage on existing issuances on existing properties.
If the same insurance coverage is not available when policies are renewed, there is a possibility that loan covenants will be violated because the required all-risk coverage may not be provided.
Another major commercial mortgage lender with a $10 billion mortgage portfolio who originates large loans for securitization has decided to protect itself by requiring terrorism insurance on all new loans.
Page 61 PREV PAGE TOP OF DOC
Borrowers frequently are unable to obtain the required terrorism insurance, making it impossible for the lender to close the loan.
The rating agencies are reacting to the lack of available terrorism insurance. Fitch & Moody's are in the process of creating new criteria to categorize this risk.
If Congress fails to pass legislation, these new guidelines could cause rating downgrades in new and existing deals.
In addition, special scrutiny is being given to the sort of small, run-of-the-mill properties in close proximity to these high profile properties because we don't know where the next attack is coming.
I am a commercial real estate lender. I am paid and trained to assess and price risk. But I am trained to deal with certain types of risk, and this is one I have no training to assess and deal with.
I can assess the risk of a K-Mart bankruptcy. I can assess the risk of a building burning down and collecting on insurance. But if I cannot assess the risk, and my borrower cannot obtain insurance, I cannot make the loan.
I submit that the time to act is now, before another terrorist incident occurs. Act now while we have the luxury of being able to give careful consideration of how a program should be crafted.
Page 62 PREV PAGE TOP OF DOC
The need and purpose of Government reinsurance backstop is to stabilize and restore confidence to the markets. If and when another attack occurs, the Federal backstop will ensure against market disruption and panic.
I urge Congress to pass terrorism reinsurance backstop legislation, and I applaud the Financial Services Committee for taking the lead in this area.
[The prepared statement of Kieran P. Quinn can be found on page 137 in the appendix.]
Chairwoman KELLY. Thank you very much, Mr. Quinn.
We move to Mr. Hunter now.
STATEMENT OF J. ROBERT HUNTER, DIRECTOR OF INSURANCE, CONSUMER FEDERATION OF AMERICA
Mr. HUNTER. Thank you, Madam Chairwoman.
Chairwoman KELLY. Mr. Hunter, will you please push the button to turn on the microphone.
Page 63 PREV PAGE TOP OF DOC Mr. HUNTER. Yes. Thank you.
Chairwoman KELLY. Thank you.
Mr. HUNTER. Thank you very much. It is nice to be back before you.
You will remember that CFA was one of the early and strongest supporters of the bill that passed this subcommittee unanimously, or the Full Committee, and went to the floor of the House, because as I testified before the Senate I was very afraid of what might happen after January 1.
We did not support the ultimate bill because we thought the tort restrictions were too Draconian, but we did think that the Committee, particularly Chairman Oxley and Chairman Baker, did a great job here at the Committee level.
Because of the lack of Congressional action last year, we got to test whether the crisis that we feared would happen, and what would happen. There were many dire predictions, and we now can test did all these dire predictions come true? And the answer is, they did not.
Terrorism coverage, which was obtainable immediately after the September attacks, is becoming more widely available in larger amounts. Premiums are falling as more insurers enter the market. That is a quote from this morning's New York Times.
Page 64 PREV PAGE TOP OF DOC The world's largest commercial insurer, AIG, has just asked the Federal Government not to offer airlines war and terrorism insurance anymore because, as Mr. Greenberg put it, we as taxpayers do not want to compete with our own Government for business that the commercial sector can underwrite.
Ground Zero's cleanup and construction project at the World Trade Center has been written in a wrapup policy by Liberty Mutual.
The capital markets raised $24 billions in 10 weeks, which is breathtaking, said Alice Schroeder of Morgan Stanley. More money was raised in new capital than actually was paid out as a result of September 11th, when you consider taxes.
Lloyds of London says that new capacity has helped brokers obtain higher limits of $50 million to $100 million easy to obtain for good risks, he said, for terrorism. And by using capacity in Bermuda and the U.S. markets, brokers can obtain $200 million, the Lloyd's broker said. Lloyd's now comfortably places $200 million of coverage for any one building.
Insurers are developing ways to rate terrorism coverage, including new computer models which have been developed for that purpose. Some larger commercial accounts are using the Liability Risk Retention Act to cover the liability part of the terrorism risk, for example airlines are doing that in Vermont.
Captive insurance companies are forming to cover terrorism, for instance, for the construction trades. Banks are freely loaning money, and Mr. Greenspan this morning confirmed that. He said, quote: ''To date there does not appear to be the case that there are any widespread problems. We have not seen any impact of that nature on the banks.''
Page 65 PREV PAGE TOP OF DOC
And I could go on with many, many more positive things. So CFA undertook a major study of the insurance market. We found that the insurance market is wealthy and overcapitalized. High rates are a serious problem for mid-sized and larger commercial insureds, but that is much more related to the economic cycle of the insurance industry than terrorism.
The larger firms are finding alternative ways to deal with the problem such as self-insurance and creation of captives, and even securitization of risk.
The rate problem is caused by their classic turn in the economic cycle, but the hard market is anticipated to be short because of the excess capital in the insurance industry.
Banks are freely loaning money. GAO has today released its report. It points to real estate and commercial lending as potential trouble spots. It cited ten examples of problems, eight of which are in these areas. The others are terror targets, a mall in an airport. Of the ten, four are located in New York, maybe more, at least four.
CFA agrees there are problems developing in certain areas, but as GAO says, quote: ''The extent of negative economic impacts of a lack of terrorism coverage is not yet clear. Ultimate impact on the economy cannot be gauged.''
This is not to say there are no problems. High prices are a serious problem because of the cycle turn. In the mid-1970s and mid-1980s, we experienced crises like this. The mid-1980s crisis was much worse than the one we are currently in. You may remember that Time Magazine had a cover that said ''Sorry, America, Your Insurance Has Been Cancelled.''
Page 66 PREV PAGE TOP OF DOC
The price increases in the hard market caused by this cycle term began in late 2000. The terrorist attack sped up these price increases into what many seasoned industry analysts see as price gouging today. But terrorism did not cause the price increases.
What should Congress do today?
One, I think you should not rush into passing a full backup bill. You should continue to have the GAO review what the problem is, and to look at the problems and see what the limits are. Real estate trophy risks, other trophy targets, particularly in New York City. You should document that.
Congress should be prepared to act if an event occurs quickly, just as you did with the airlines. GAO raises the important question of how to deliver payments, but there are ways to do that. Even the insurance companies do not have adjusters to cover say major earthquakes, and there are services available for ways to deliver money if you decide to do something after the fact.
You may decide to target the ultimate bill, if there is one, to the specific risk. the terrorist targets and the trophy risks. Those are the problems. So maybe something like a coverage only in excess of a $500 million retention per entity.
Big business wants an all-industry bailout rather than a specific backstop. I don't think they need it.
Page 67 PREV PAGE TOP OF DOC Second, if any Federal backup bill is required, the House version is the right way to go in terms of a payback mechanism. We totally agree with that.
Third, we think you should consider developing private sector alternatives. For example, expanding the Liability Risk Retention Act to cover property insurance. Why shouldn't the wholes of these aircraft be able to be covered by the airlines, just like they are going to cover their liabilities? The Risk Retention Act is a very important tool to give alternatives to the private sector.
And finally, any bill that does pass you have to address rate gouging. If you pass a backup bill, it would be foolish to not have a price reduction as part of the bill. I would be happy to answer questions at the appropriate time.
[The prepared statement of J. Robert Hunter can be found on page 142 in the appendix.]
Chairwoman KELLY. Thank you, Mr. Hunter. I read your testimony. I found it very interesting, but it certainly seems to me you may not have interviewed the other panelists.
We move now to Ms. Schroeder.
STATEMENT OF ALICE D. SCHROEDER, SENIOR U.S. NONLIFE EQUITY INSURANCE ANALYST, MORGAN STANLEY.
Page 68 PREV PAGE TOP OF DOC Ms. SCHROEDER. Thank you. Good afternoon, Madam Chairwoman and Members of the subcommittee:
I appreciate the opportunity to appear before you today. As an equity analyst, I am an observer of the industry, but I also represent the owners of the companies who supply capital to the industry, and I am the only representative of the owners of the insurance companies here today.
The risk of terrorism which was formerly borne by insurers is now being distributed more broadly throughout the economy. This afternoon the financial institutions research team of Morgan Stanley issued a report on this subject.
We have analyzed the real estate, banking, asset management, and insurance industries to discuss and understand how the risk has shifted out of the insurance industry toward other sectors of the economy.
Collectively we estimate that there are approximately $12 billion of assets exposed in the commercial area in the United States, excluding homes and personal assetsexcuse me, $12 trillion, which obviously greatly exceeds any capacity that the insurance industry could possibly hope to provide for terrorism coverage.
There is no possible way the insurance industry could deal with that.
Lenders have shown varying degrees of concern about the lack of coverage in their portfolio, depending on their business mix, with many beginning to demand coverage. Others, we are aware, have begun to ask borrowers to explicitly self-insure, shifting the risk directly to their customers.
Page 69 PREV PAGE TOP OF DOC
Property and business owners are seeking insurance coverages, but they are generally not finding it for the higher risk properties, and for large groups of employees for workers compensation.
Many, however, still have coverage which will expire later in the year. And those who have already lost coverage appear to have varying levels of concern depending on how they assess their own risk.
Mathematically, the effects of customers and insurers to avoid the risk collectively does not protect the economy against terrorism. The risk has only been redistributed.
We think you need to understand the assumptions that are being made by participants in the economy in thinking about this, as we have discussed them with many people.
It appears that many are assuming that if there were another event, the Federal Government would provide essentially unlimited post-event funding; that the funding would be in proportion to economic losses regardless of insurance coverage; and that any capital destroyed, any debts owed, and any insurance claims owed would all be paid by the Government.
It also appears that some may be assuming that any further attacks would be an act of war. In other words, that insurance coverage might not even apply.
We also believe there are other reasons why there has not been more panic and visible economic disruption, including the fact that insurance policies renew throughout the year, and that many people are assessing their individual risk odds as low. But it is important to separate panic behavior from real economic disruption.
Page 70 PREV PAGE TOP OF DOC
As analysts, we deal in facts and data. And the economic disruption is the fact that significant risk has been shifted from insurers to their customers. That is a fact. It is a simple economic fact that we believe cannot be disputed.
Even if every exposed party retains its own risk collectively and has no complaints about doing so, the risk remains in the economy and has not been addressed.
We believe, however, that complaints about the disruption will worsen over time because as more insurance policies renew, more coverage will be lost. And the limited insurance capacity that is available is being used now by those whose coverages are expiring early in the year. So you have some inequities that may result from that.
The insurance industry will develop over time some additional capacity for terrorism coverage, but it will fall far short of the requirements.
For example, the $20 billion of capital that was raised by the industry last fall was all raised by investors for the reinsurance industry, and that money is not being used to cover terrorism, and those investors certainly had no intention of covering terrorism risk.
The rating agencies commented that there was a rating threat here, but so far there have been no downgrades. We expect that over time that may change.
And finally, institutional investors currently are in a state of ignorance, not seeing disclosure. They would certainly like to know more about their investments and what the status of the equities that they own have.
Page 71 PREV PAGE TOP OF DOC
The SEC is considering this issue, but we are certainly in favor of disclosure.
So to sum up here, a brief perspective on the insurance industry. From the point of view of an equity investor, insurance companies generally destroy rather than create value for their shareholders.
They compete for market share ferociously and are quick to underprice their product, given the opportunity. From our perspective, customers get an extremely good deal subsidized by shareholders, and if insurers could gain market share by covering terrorism, we believe they would be doing it right now if there were any way to underwrite terrorism successfully. We simply do not believe there is.
The shortage of insurance capacity, along with the simple and obvious mathematics of terrorism losses, indicate to us that there is a problem here that needs to be solved. So on behalf of the shareholders who provide critical risk capital to this industry, we urge your careful consideration of these issues.
One thing to especially keep in mind is whether the shareholders will recapitalize the industry if there is another event.
[The prepared statement of Alice D. Schroeder can be found on page 171 in the appendix.]
Page 72 PREV PAGE TOP OF DOC
Chairwoman KELLY. We thank you very much, Ms. Schroeder.
Mr. Mair, I would like to ask you a question or two.
As the representative of the commercial consumers, the businesses most directly affected by a lack of terrorism coverage fall into your category, and I wonder if you could explain to us the risk transfer that is occurring from insurers to the businesses and the vulnerability of commercial policyholders to another terrorist attack from your perspective if they fail to obtain terrorism coverage.
Mr. MAIR. As I said, Madam Chairwoman, the RIMS membership includes approximately 84 percent of the Fortune 1000, and on the smaller end, over 900 businesses with less than 500 employees.
Those small organizations rely on insurance coverage to recover from catastrophe. In the absence of that, those companies simply do not have the resources to reopen their doors again.
By example, in the middle sector in my organization, every dollar that I pay for insurance is a dollar that the U.S. Olympic Committee cannot use to train athletes. It is a dollar that a company of my size cannot use to pay an employee to pay for health benefits.
On the uppermost end, these are companies that have the ability to retain more of that risk, to spread more of it across multiple properties, but still yet those are going to have an impact should those losses materialize, or should those higher costs continue to be absorbed by those organizations.
Page 73 PREV PAGE TOP OF DOC
Simply put, those are going to be transferred through the chain, through the supply chain, to the ultimate buyers, to the consumers.
Chairwoman KELLY. Thank you.
Mr. Mair, your fellow panelists here, Mr. Hunter, in his testimony wrote that larger firms are finding alternative ways to deal with the problem such as self-insurance, creation of captive insurance companies, and securitization.
You represent the companies you spoke of, the Fortune 500 and Fortune 100 companies, and a lot of smaller businesses. Do you find this to be the case? Or are there large companies that are in need of this Federal legislation?
Mr. MAIR. Let me answer those questions in reverse order.
There are clearly large companies that need this legislation. It is dynamic, it is required, and it is required today.
The same companies that are banding together to form captives, to use alternative risk transfer vehicles, still look to the reinsurance markets. They are not banding together and creating those captives for unlimited losses. They are all capped within working layers of loss that are predictable and understandable and fundable.
Where the reinsurance industry has pulled itself away, where it has left, they are left with the fullness of that liability. And none of them, even the largest, have the ability to absorb that on their own.
Page 74 PREV PAGE TOP OF DOC
And by the way, I really disagree with something. You mentioned Mr. Hunter's testimony. I have to tell you on behalf of the consumers of insurance, I really strongly disagree with the Consumer Federation of America's assertions. I think they have looked at the right fact patterns, but at best hit the outer ring of the bullseye.
Chairwoman KELLY. Thank you, very much.
Ms. Schroeder, how many investors do you think are aware that their investments may no longer be protected by terrorism insurance? And if the Senate fails to act, is this not putting both the investors and the lenders at a significant risk?
Ms. SCHROEDER. Yes. Investors are in a state of ignorance right now because they know there is risk, but there is no disclosure of lack of insurance. So there is a creeping miasma of risk out there and concern, but they don't know which companies to apply it to because, while insurance coverage has been withdrawn, they do not know yet if the policy has expired for the company that they happen to own, for example.
They know that risk is rising, and they are. generally speaking, aware. There are certainly varying levels of awareness among investors however, and we believe investors are becoming more aware of that. For example, Lehman and Morgan Stanley this week have both issued major reports on this matter, the first to be issued.
So we expect that over time investors are going to become more and more concerned.
Page 75 PREV PAGE TOP OF DOC
Chairwoman KELLY. Thank you.
Ms. Beck, why do you think some real estate transactions are occurring in the face of the unavailability problem?
Ms. BECK. Well, I know of one in Chicago that took place and was sufficiently interested to find out how, since it was a large transaction. And I did call and found out that the owners have a blanket policy in effect until early summer. Because of their relationship with the insurance company that had provided the blanket, they were able to include the new purchase in the pre-9/11 existing blanket policy.
But, as I mentioned on renewal, now there is no blanket coverage being provided for large portfolio owners. I might also, if I may ask your indulgence, comment on Mr. Hunter's analysis of the situation.
I wish I were as sanguine as he that if we waited long enough the free market would come up with a solution. I just wonderand this may be a little unfair, Mr. Hunterbut I just wonder if you were hanging over a cliff, if you would like to wait there while someone created a business to rescue you.
Chairwoman KELLY. Thank you, Ms. Beck.
Mr. Hunter, do you want to attempt an answer here?
Page 76 PREV PAGE TOP OF DOC [Laughter.]
Mr. HUNTER. Sure. Well, actually I think there are some problems. I said that. And I think the Congress needs to reconsider how to address the real problems that may exist in certain limited parts of the economy. That is just not the kind of situation that was predicted; it is not happening; and you cannot create it. It is just not there.
Chairwoman KELLY. Well, Mr. Hunter, it has been 6 months since 9/11
Mr. HUNTER. And one-third of the direct insurance is now written because 25 percent of the commercial business comes up on January 1 of the direct business, not the reinsurance. Seventy percent of the reinsurance expired on January 1, but 25 percent of policies attached on January 1, the direct policies, and since then aboutso we're at about a third of the policies out there and we're not hearing anything.
Ms. BECK. May I comment?
Chairwoman KELLY. Ms. Beck, yes.
Ms. BECK. Thank you, Madam Chairwoman.
I think that when Mr. Hunter says that the policies have been written, he is not aware perhaps that acts of terrorism have been excluded from coverage.
Page 77 PREV PAGE TOP OF DOC In the States that are not covered by the ISO exclusion, which permit States to allow insurers to exclude terrorism coveragein the States that still are not approving that exclusion, you have 35 percent of the commercial property market.
In our market in New York, I know for certain that several billion dollars worth of real estate is either grossly under-insured for terrorism, or has had no coverage for terrorism in those same 3 months. And I know that in a survey that you did, Mr. Hunter, you may not have had access to nor would it necessarily have been disclosed to you, because, as I mentioned in my testimony, property owners are frightened to make public this fact, either to potential terrorists or to their investors or lenders or anyone else, for that matter, including their tenants who also might be frightened knowing that there is no coverage for acts of terrorism.
Furthermore, anybody who has renewed insurance is not getting coverage for the very risks that I think our Government is most concerned about: bioterrorism, chemical or nuclear terrorist acts.
I do not question that what you have in your study is correct, but it is missing are some of the most critical underlying facts affecting the large commercial properties.
Chairwoman KELLY. Ms. Schroeder, did I see your hand on that?
Ms. SCHROEDER. Yes. I was just going to add that there has been some evidence from the NCCI which runs the Workers Compensation Pool that since January 1 it has become very, very difficult for large employers to buy workers compensation because you cannot exclude terrorism coverage from that product. And that is a very significant shift since January 1, which would indicate that the lack of reinsurance coverage is what is triggering the primary companies to stop selling the product to large employers.
Page 78 PREV PAGE TOP OF DOC
Chairwoman KELLY. Thank you.
I am out of time, so I am going to turn to Dr. Weldon.
Dr. WELDON. Yes. I have a question for Mr. Hunter. Those tort provisions, you referred to them as being Draconian, I would like you to amplify on that just a little bit, because I thought if we were going to be putting basically the Treasury of the United States at risk for coverage for these things, it was reasonable to place some restrictions on the trial bar to raid the Treasury.
And I am just a little shocked to hear that from you. You know, you go to buy a ladder at K-Mart or Wal-Mart, it is about twice the price it should be because of the insurance on the ladder and all that.
So from a consumer perspective, can you explain where you are coming from on that issue?
Mr. HUNTER. Sure. Well, I supported tort restrictions as it passed this Committee. There were restrictions.
Dr. WELDON. OK.
Page 79 PREV PAGE TOP OF DOC Mr. HUNTER. And I supported that.
Dr. WELDON. So when the question was before the Committee
Mr. HUNTER. It went to the floor and they tacked on a whole new set of much broader restrictions that went way beyond just terrorism, and I was opposed to that. I thought it wasfirst of all, it was non-germane, and second, it was Draconian.
Dr. WELDON. Ms. Kramer, did I understand your testimony correctly that you now have a lot of exposure; that you just cannot get insurance?
Ms. KRAMER. Well, that is absolutely right. We cannot get coverage for terrorism. And that applies not only to the hospitals and agencies in the FOJP program, but as I mentioned we've talked to the hospitals in Upstate New York and I know from personal experience hospitals outside of New York City and New York State are experiencing the same thing.
I want to just comment for a moment on both what Mr. Mair said and also what Mr. Hunter said. Mr. Mair made the point that the problem may be up at the reinsurance level. We have a captive, but that captive is in no way, shape, or form able to subsidize and take care of terrorism coverage.
When we go to our insurance companies, the primary carriers happen to be excess and surplus lines companies and they do not even need approval. They do not need the approval of the Superintendent of Insurance in New York for excluding terrorism.
Page 80 PREV PAGE TOP OF DOC
Then you move to the reinsurers and their prices are, when you can get a little bit of coverage, are exorbitant. The hospitals and the agencies in our program, the hospitals particularly, are cash-strapped. They have only got a few weeks of cash on hand.
In the September 11th attack, two of our hospitals were seriously affected and, fortunately, because of our program pre the last renewal, had coverage for major business interruption losses.
In addition, our agencies throughout the city who had to gear up to take care of victims of September 11th and their families, their services were also interrupted. So you are talking about thousands of people in the City of New York who are not getting the health care services, or access to it, let alone social service agency services all because of a terrorist act. And that one was covered. The next one is not.
Dr. WELDON. Does your organization consider itself at higher risk to be targeted in light of the virulent anti-semitic sentiments of these terrorists?
Ms. KRAMER. Well, bear in mind that the agencies and the hospitals are non-sectarian, and therefore offer their services to people of all walks of life, all religions, races, and so forth.
Dr. WELDON. But the name on the door is
Ms. KRAMER. The name on the door of my organization, FOJP Service Corporation, of course, has Federation of Jewish Philanthropies in the title. But the hospitals and the agencies are not necessarily, you know
Page 81 PREV PAGE TOP OF DOC
Dr. WELDON. Labeled that way.
Dr. WELDON. OK. Mr. Hunter, do you want to comment on this situation? We have got a major charitable organization in this country that is exposed.
Mr. HUNTER. Yes. Obviously I think the major kinds of risks that are exposed, particularly if they are targets, I think Congress should consider if there is some role for Congress maybe coming in at the high level as an excess carrier, because I think you can get lower levels of terrorism coverage for terror.
But I do not think you need to take that and then expand that to a general bill the way the current bill stands as it passed the House. I do not think you need that kind of general coverage anymore. I do not think it is necessary, based upon what we are learning.
Dr. WELDON. I see some people who want to respond to that.
Ms. BECK. I would like to mention that I have been discussing the issue with representatives of another major religious organization that is not affiliated with Ms. Kramer's, but has many, many properties throughout the country. I have given its name to the General Accounting Office, because I just learned on Monday that they were prepared to talk to the GAO. Unfortunately, my message did not get to the staff in Chicago. The insurance dilemma is a widespread problem for religious institutions of all denominations across the country.
Page 82 PREV PAGE TOP OF DOC
I think that we are very fortunate that Ms. Kramer is here today, because in her example she had insurance that was to be renewed, I believe you said on November 1st, and that is really germane here, because we have this staggered schedule of renewals coming up.
And there are still a large number of entities that have insurance written before 9/11. But what you are hearing today is analagous to the Galapagos Islands, tips of volcanic mountains. In the ocean, if the Pacific starts receeding you are going to see this problem in stark reliefand it will worsen if Congress does not actcreating some reinsurance mechanism must be done, and done very quickly.
Mr. HUNTER. You know, Mr. Weldon, if that is true that there are many religious institutions with this problem, that is a classic example of why you would want to look at the Risk Retention Act as possibly expanding it. Because the Risk Retention Act which helped solve the liability crisis of the mid-1980s and the mid-1970s, is limited to liability insurance. And it allows groups to get together all over the country and form to either buy insurance as a group, or to self-insure themselves.
And it is a very good tool, because it offers alternatives. It also kind of scares the insurance companies into making more reasonable bids. And it is something that should be looked at, because Congress in both the last crises we had like this used that tool, and I think it would be a perfect tool if you expanded that to property and workers comp here.
Dr. WELDON. Did you want to comment on that, Ms. Schroeder?
Page 83 PREV PAGE TOP OF DOC Ms. SCHROEDER. Yes. I just do not view that as a feasible solution because the kind of small events that a risk retention group could handle, you could already buy adequate coverage for.
The kind of large events that you need coverage for, no risk retention group could possibly capitalize. So economically I think it is a good idea, but I think you already have capability to cover those kinds of risk.
The insurance industry is happy to provide capacity for small, reasonable acts of terrorism that they have the capacity to cover. It is the large events that they do not have the capital for. And if the entire insurance industry does not have the capital, how can a risk retention group made up of non-profits do it?
Ms. BECK. And that is our point, as well. We were approached by several hospitals as though we had the capital to invest in starting up a risk retention group, and there might be one or two hospitals in the New York State or New York City area that have some capital to throw at this problem. But these are, as I said, cash-strapped institutions. They are not-for-profit and they cannot afford to self-insure or go into a risk retention group, and there is no affordable coverage being made available from any of the insurers or reinsurers.
Our concern is that, as the cost of this coverage has become prohibitivecovering the expense takes money as it is transferred to an operation that previously did not cost near this much in terms of funds.
That situation is simply going to raise the cost of health care in New York and elsewhere. How else are you going to pay for the physicians and the services?
Page 84 PREV PAGE TOP OF DOC
Mr. MAIR. Mr. Weldon, if I might, before you conclude your time, Mr. Hunter cited three sources in saying to you that there is coverage available. He cited today's New York Times in which Joe Treaster indicated that there was coverage widely available at reduced costs.
I spoke with Mr. Treaster in an interview for that article yesterday, and what he indicated to me was he was able to find one program in which the cost had gone from 20 cents on the dollar to 5 cents on the dollar.
With all due respect to Mr. Treaster, you can sell me the Hope Diamond at half its value and I still cannot afford it. It does not become available.
Mr. Hunter also made reference to Lloyd's, and the fact that coverage was available there. Lloyd's is beginning to exclude fire-following coverage, an issue that is growing in 30 States now in which that coverage remains even following the terrorism exclusion.
That does not suggest to me that coverage is available.
And he cited, as well, Hank Greenberg, Chairman of AIG, saying that on the aviation side that Government need not do anything. Well, in that same New York Times article, Mr. Greenberg is cited as saying that Congress not acting is like going to war without an army, and urged the Congress to act.
I concur with Mr. Greenberg in that respect. And again, thank you for allowing me to interrupt.
Page 85 PREV PAGE TOP OF DOC
Dr. WELDON. By the way, the way I deal with the New York Times is that I just don't read it.
Dr. WELDON. If the Chairlady would just indulge me for one little question, could you, Ms. Schroeder, could you just explain to me how insurance companies destroy equity?
Ms. SCHROEDER. Yes. How they destroy equity is they sell the product too cheaply. Insurance is a derivative, and by that I mean that the premium they charge is a fraction of the risk that they take on.
So when they underprice the product, they can destroy massive amounts of value. Over the last 10 years, insurance companies have earned on average on their capital 8.5 percent, which is about what a corporate bond would earn. And that is on average.
That is during a period when they got big windfall gains from being invested in equities. And if you took those windfall gains away, they would have lost money.
They also got big windfall gains from basically deflation of their costs that were nothing that they did.
The risk that an investor takes on from investing in a stock, they need to get paid for that risk more than a bond. So value destruction is if you only get paid what you get for owning a bond when you're taking the risk of an equity, and especially when that return you did get came from something that was an accident like the equity market, not from the basic business of selling insurance.
Page 86 PREV PAGE TOP OF DOC
The insurance companies typically lose something like 10 cents for every dollar of premium that they sell on the basic business of selling insurance. So customers get a $1.10 worth of claims and expenses for every $1 they give to the insurer for premiums.
Dr. WELDON. Thank you, very much. I will go sell all my insurance stocks immediately.
Ms. SCHROEDER. Most people do.
Dr. WELDON. Just kidding about selling those stocks.
Mr. HUNTER. They're up at a rate of 15 percent since September 10th.
Ms. SCHROEDER. And where are they from 1998?
Chairwoman KELLY. Thank you very much, Dr. Weldon.
I want to go to Ms. Kramer just for a second. Ms. Kramer, I want to tell you that because of the area that I represent in New York, I am well aware of the Federation of Jewish Philanthropies and all of the good work that you do. You are all over my District doing wonderful things, which is why I am so concerned about your risk.
Page 87 PREV PAGE TOP OF DOC
According to the GAO report, that exclusion that is being used by the insurers excludes not only terrorism but also the commission of any dangerous or violent act intended to intimidate any segment of the population, or to express any opposition to a philosophy or ideology.
I am concerned, ma'am, that you are able to get insurance to keep on doing those good works in the face of potential for criminal activity for bioterrorism, things like that.
I would like you to speak to that, because I think that your risk is increased in that regard.
Ms. KRAMER. Well, let me say two things.
First with regard to the hospitals in our program, we have more than just Jewish hospitals. Right in New York City, you know, we have got hospitals from other religious affiliations as well as I commented on Upstate New York.
Now second, we have already encountered not only difficulty but it has been impossible to get bioterrorism coverage. So what do we see? We see hospitals all over the United States preparing their disaster recovery plans so that they can treat the public in the event of a bioterrorism attack. But who is there for them?
And so at the cost of treating the public, there will be no coverage and no money available to rebuild or to cover property that is damaged, or people's lives and health that is injured, and that is the problem. Where will the money come from for them?
Page 88 PREV PAGE TOP OF DOC
So my concern is that we have already seen and encountered the difficulty. We cannot get bioterrorism coverage.
Chairwoman KELLY. So as long as the Senate does not act on this bill, you are continuing at risk?
Ms. KRAMER. We are.
Chairwoman KELLY. And so are the people, the women, the children, the families that you serve?
Ms. KRAMER. All of those segments of the population are extremely vulnerable right now, and that is why we think it is important that Congress act now as opposed to putting this off any longer.
Chairwoman KELLY. Thank you very much.
I just want one final question to you, Mr. Quinn.
Mr. Hunter says that there is little if any problem with loans in the current market for terrorism insurance. I would like you to tell me if you agree or disagree with that statement.
Mr. QUINN. I strongly disagree. I think he made a comment earlier that banks are lending. Banks make all types of loansconsumer loans, lines of credit to buy inventories and to finance accounts receivables. The world that I live in lends on commercial properties, a specific loan on a specific asset.
Page 89 PREV PAGE TOP OF DOC
It even goes broader than that. The financial markets that we operate in rely on confidence. Insurance is a critical component of the collateral that I lend on and the confidence behind the industry that I work with. It is vital to everything that we do.
Chairwoman KELLY. What effect would another terrorist attack have on your business and on your industry if Congress fails to pass this terrorism insurance protection?
Mr. QUINN. If I cannot get insurance on these properties, I cannot make loans. I am the permanent lender. I am the one who takes the construction lender out, or the bank loan out. All these loans will back up at the banks and they will be unable to make any new loans, and construction will grind to a halt.
Chairwoman KELLY. As I would assume, Ms. Beck, real estate transactions would also, because the banks cannot do the loans on those, either.
Ms. BECK. Well, we are already seeing that. But I think that, while lenders are making commitments on a lower loan-to-value ratio now than since the early 1990s when they had to foreclose on a number of properties because of our economic decline at that time, I think lenders will face a real problem if owners cannot get the terrorism insurance and the building is, in fact, destroyed. The lender generally having a non-recourse loan will be totally out-of-pocket for that particular piece of property.
I hope we will not have any further terrorism incidents. Were that so, the FISC will be protected even with legislation passed by the Congress, because we comtemplate backup insurance in the event of an attack. FISC is not saying, ''We are going to hand out money now.''
Page 90 PREV PAGE TOP OF DOC
This is a very important distinction to make in talking about this subject. We have a Financial Committee at the Real Estate Board of Lenders and Mortgage Brokers that meets monthly. From what I am hearing, since January first, no large loans have been made on either renewals or on transactions.
This is very, very serious. I cannot promise that we can get you all the data, but we are hearing in our private meetings that this crisis is just going to continue to get worse and worse. Without congressional action, you can expect a domino effect that will be increasingly evident as the months pass.
Chairwoman KELLY. Well, certainly there does seem to be a concern when you have the Administration confirming the likelihood at or near 100 percent of our having another terrorist attack. There certainly is a concern.
There are, I am sure, questions from other Members who have not been able to get to this hearing today. I want to make a note of that and say that, without objection, I am going to hold the hearing record open for 30 days so that Members can submit written questions to the witnesses and we can place their responses in the record.
I want to especially thank this panel for honoring us with the time that it took for us to get through this hearing, and for being so very patient with that delay and with the quality of your answers here today.
This panel is excused with the subcommittee's great thanks. With that, this hearing is adjourned.
Page 91 PREV PAGE TOP OF DOC
[Whereupon, at 6:20 p.m., the hearing was adjourned.]