This article originally appeared in the Spring 2017 issue of CLM sister publication, Construction Claims magazine. All rights reserved.
Consider the following hypothetical: New turbine parts are en route to the construction site of a state-of-the-art power generating facility when the design-build team receives word that unknown actors have perpetrated a series of assaults and detonated explosive devices impacting directly the on-site turbines themselves, the roadway leading into the construction site and the power coming into the operating areas of the project. The acts are believed to be related to a group with ties to an extremist environmental agenda. Early reports are labeling this an act of domestic terrorism, and multiple agencies have been called in to investigate. The contract to build these four state-of-the-art gas turbines is worth north of $500 million. Damage estimates are not yet known. The executive team is meeting, and the urgent topic of conversation is terrorism insurance. Nothing could be more important for the construction lenders and the shareholders to be assured immediately that the delay, replacement and repair of the infrastructure is properly covered and the project’s bonds are not placed at issue.
While the above is a hypothetical, the scenario is neither far-fetched nor unfamiliar. Many similar events are discussed in Amory Lovins’ book Brittle Power. Various acts of trespass and vandalism since 1980, including an event by “peace” activists as recently as July 2012 at the Y-12 National Security Complex in Oak Ridge, Tenn. (which manufactures U.S. nuclear weapons and stockpiles highly enriched uranium), have shown how vulnerable power facilities can be targeted.
The Tipping Point
Terrorism risk in the United States prior to Sept. 11, 2001, was not thought by the insurance industry to present a capital capacity problem. Coverage for domestic terrorism incidents had been embedded in property and casualty policy forms, and no premium had been charged by most underwriters for the terrorism coverage. This was true despite exclusions such as the “War and Military Action” exclusion being determined by courts to be inapplicable in the context of terrorism claims. See, Pan Am World Airways, Inc. v. Aetna Cas. & Sur. Co., 505 F.2d 989 (2d Cir. 1974).
The two largest pre-9/11 domestic events—the 1993 World Trade Center bombing and the 1995 Oklahoma City bombing—while painfully costly for the markets, were absorbed; the reinsurance market functioned with sufficient capacity to distribute the losses effectively. However, following $40 billion in estimated loss payments flowing from the terrorist incidents of Sept. 11, terrorism became a risk that had to be properly contained so as not to impair property and casualty markets. The solution involved the intervention of the federal government, and after a short time, terrorism insurance became a robust product that has gained a foothold in almost every industry segment with uptake rates near or exceeding 60%, according to the 2016 Marsh Terrorism Risk Insurance Report.
Any retrospective on terrorism insurance in the United States must first acknowledge that the landscape has shifted considerably in terms of both actors and targets. Hard targets injured consequent to airplane hijackings or well placed explosives in public subways or buildings by well organized and well financed militant groups have given way to soft, unguarded targets assaulted by individuals, so-called “lone wolf” actors, whose radicalization can often be attributed, even if not directly linked, to terrorist state actors. There are also acts by individuals, frequently described as “unaffiliated actors,” whose ire is directed at other objects of antipathy, such as private businesses, abortion clinics, public speaking events and other victims—including individuals, groups and institutions. Questions of mental illness and personal ideology have made defining and characterizing any event as an act of domestic terrorism subjectively and objectively difficult.
Many of the domestic incidents since 9/11 listed on the Global Terrorism Database have involved “active shooter” scenarios or low blast-radius explosions. Consequently, the resulting harm to property and infrastructure has been less impactful on policyholders and insurers than the harm to human life and overall business activity. Business interruption, injury to employees, delay in or cancellation of travel, interference with communications, and disruption in time-sensitive projects during the event and succeeding investigation are more likely outcomes than wholesale property destruction on the scale of Oklahoma City or New York City.
In the “Brittle Power” scenario cited above, the real cost of repair or replacing an in-place turbine could exceed $3 million, but the resulting business interruption and contract disputes arising from the disruption of the project could change the equation and cause damages many times the cost of repairing the equipment.
As further discussed below, whether these types of potential losses are properly insured by construction industry stakeholders under their terrorism endorsements could depend largely on the competency of the risk management team, national political considerations and the degree to which damage levels attain certain thresholds.
“Certified Acts” Coverage Under TRIA/TRIPRA
In the immediate aftermath of 9/11, the property and casualty industry reacted with great concern, looking to exclude coverage for terrorism events or properly price that which they had previously insured essentially for free. Global reinsurance underwriters became unwilling to reinsure the terrorism risk. Pricing the terrorism risk became problematic, and it further became apparent that the detonation of a “dirty” device or the release of a toxin in a crowded urban work environment could easily exhaust a significant percentage of the capital in the insurance industry. Demand for industry protection in the face of such devastation, uncertainty and exposure led then-president George W. Bush to sign legislation providing a federal “backstop,” or risk sharing mechanism, for participating underwriters that has functioned successfully since 2002.
Initially known as the Terrorism Risk Insurance Act (TRIA), the law was amended, revised and reauthorized in 2005, 2007 and 2015. Now known as the Terrorism Risk Insurance Program Reauthorization Act of 2015 (TRIPRA), the loss-sharing mechanism promises to continue until Dec. 31, 2020. Uncertainty surrounding the periods prior to sunset of the law on previous occasions has demonstrated that the insurance markets still depend on these backstops for protection.
In its initial iteration in 2002, TRIA provided that insurers were required to offer terrorism coverage with limits equal to the non-terrorism coverage. The government agreed that the U.S. taxpayer would participate in loss sharing if (and only if) the secretary of the Treasury “certified” a specific event as an act of terrorism. The certification criteria to be employed by the secretary amounted to a four-part test: (1) there must be a violent act or an act that was found by the secretary to be dangerous to human life, property or infrastructure; (2) that resulted in damage within the United States, or outside of the United States in the case of U.S. air carriers, vessels and/or missions; (3) that was committed by an individual or individuals as part of an effort to coerce the civilian population of the United States or to influence the policy or affect the conduct of the U.S. government by coercion; and (4) that resulted in losses in excess of $5 million.
The TRIA legislation had as its primary goal providing immediate market stability without distortion or interference. This legislative program was especially important as the industry reinsurance capacity for absorbing another 9/11-type event evaporated because expiring treaties expressly eliminated reinsurance for any act of terrorism. Under the legislation, the government offered to become a participant in the payment of loss after: (1) industry losses from a “certified” event rose to a “triggering event threshold”; (2) required individual insurer deductibles (based on a fixed percentage of direct premium) were paid; and (3) individual insurer retention payments were tendered.
The event threshold, deductibles and co-payment levels have increased with each reauthorization of TRIPRA. As of the 2015 reauthorization, Congress set the event threshold at $100 million, but it was programmed to rise to $200 million in 2020. Deductibles were set at 20% of direct earned premium. By 2020, when the law is scheduled to sunset, the individual retained percentage, which was set initially at 15% in 2015, will reach 20%.
In addition, an overall aggregate cap of $100 billion dollars was adopted and reaffirmed in 2015. Annual aggregate retention caps were placed on the participating industry members equal to the lesser of (1) the total of all insured losses or (2) $29.5 billion, with this amount scheduled to increase by $2 billion per year until attaining $37.5 billion. When the aggregate threshold reaches $37.5 billion, the Treasury secretary will thereafter calculate the threshold based on the annual average of the sum of insurer deductibles for the previous three years.
The federal backstops have removed significant levels of risk and uncertainty from the insurance market as a whole while preserving and cultivating private insurance for terrorism risk. By way of summary, an individual act of terrorism, to be eligible under TRIA/TRIPRA, must be certified jointly by the secretary of the Treasury in consultation with the secretary of Homeland Security and the attorney general of the United States. Losses must exceed $5 million in the United States or to U.S. air carriers or sea vessels. The federal government then shares in an insurer’s losses due to a certified act of terrorism only if the aggregate industry insured losses resulting from such certified act of terrorism exceed the applicable event threshold.
Each insurer is responsible for paying out a certain amount in claims—known as its deductible—before receiving federal coverage. An insurer’s deductible is proportionate to its size, equaling 20% of an insurer’s annual direct earned premiums for the commercial property/casualty lines of insurance specified in TRIA. Once the aggregate loss event threshold and 20% deductible are exceeded, the federal government covers 80% of each insurer’s losses above its deductible until the amount of aggregate loss exceeds $100 billion.
The federal program covers only commercial property and casualty insurance, and it excludes by statute several specific lines of insurance: federal and private crop or livestock insurance, private mortgage insurance, title insurance, financial guaranty insurance of single-line guaranty insurers, medical malpractice, flood insurance, reinsurance, and all life insurance products.
Policy Wording, Choice and Market Availability
Terrorism insurance comes in two types: a TRIPRA endorsement coverage type and a stand-alone coverage type that is not federally backstopped. Terrorism insurance is not a mandatory purchase for our construction industry members under TRIPRA. The only requirement is that the insurer must disclose and offer the coverage. TRIPRA legislation does preempt state law with respect to defining what a “certified act of terrorism” is or is not but allows state law to regulate in the area of “non-certified acts of terrorism.”
The fundamental concept for a construction entity to understand is that, under TRIPRA, “certified event” terrorism coverage may provide no coverage at all unless and until there has been $5 million in total aggregate loss from all persons who have suffered under the event. This includes those who have not filed a claim, and it includes business interruption claims. The determination of the activation of this threshold can take the federal government considerable time.
Most states will not allow exclusions of coverage for acts of terrorism that fail to be certified losses solely because they fall below the $5 million threshold in Section 102(1)(B) on any policy that provides coverage for acts of terrorism that fail to be certified. Not all TRIPRA endorsements, however, provide for such coverage.
In certain states, terrorism exclusions are not permitted to impact direct loss by fire during the event, but they can impact consequential loss.
Further, most states will allow some significant limitations on policies that provide coverage for other acts of terrorism under certain circumstances. For example, for policies providing commercial liability insurance coverage, the following limitations apply to non-certified losses: (1) Exclusions for acts of terrorism apply only if the acts of terrorism result in industrywide insured losses that exceed $25 million inclusive of related incidents that occur within a 72-hour period, or 50 or more persons sustain death or serious physical injury for related incidents that occur within a 72-hour period. For purposes of this provision, serious physical injury means: (a) physical injury that involves a substantial risk of death; (b) protracted and obvious physical disfigurement; or (c) protracted loss of or impairment of the function of a bodily member or organ; (2) Exclusions for acts of terrorism are not subject to limitations above if: (i) the act involves the use, release or escape of nuclear materials or directly or indirectly results in nuclear reaction or radiation or radioactive contamination; (ii) the act is carried out by means of the dispersal or application of pathogenic or poisonous biological or chemical materials; or (iii) pathogenic or poisonous biological or chemical materials are released and it appears that one purpose of the terrorism was to release such materials.
It is vital for the construction risk manager to understand that the coverage that may appear to be present for non-certified losses up to the $25 million is conditional. The threshold limitation does not act like an insurance limit. Instead, the threshold, once breached, eliminates all coverage for any loss that is not a certified loss. This is a point that can be misunderstood completely and have drastic consequences when claims are presented to the underwriters. Since insureds experiencing terrorism losses are not likely to share claim information in the early stages of a terrorism incident, what may appear to be covered from the outset might not be covered when all the claims have been presented if the aggregate losses exceed $25 million from all sources, whether they are presenting claims or not. It is, therefore, prudent to wait and retain legal and insurance professionals if there is a potential that the secretary will not be certifying an event.
Do you suppose that in our hypothetical scenario these limitations were considered when the project was sent out for bid? Construction risk managers should pay careful attention to policy wording to assess whether TRIPRA coverage is adequate and whether non-certified coverage is available under the Terrorism Endorsement. For construction lenders, TRIPRA Endorsements may be a prerequisite for contracting, but the coverage available under a TRIPRA Endorsement may not provide sufficient security, because it depends largely on the determination of three government officials who may have divergent political interests. It can further depend on the scope of the terrorism incident and the number of other impacted entities. Before embarking on high-dollar infrastructure construction projects, particularly those in vulnerable industries and geographic areas, a thorough review of the terrorism coverage is in order.
Ultimately, it may be prudent to purchase stand-alone terrorism coverage for sensitive domestic and international cross-border projects, defense industry projects, power grid, airport or government projects, or controversial pipelines or drilling projects.
Stand-alone coverage, which had its origin overseas, particularly in the Mideast, has now grown steadily in the United States since its introduction around 2006. Stand-alone coverage can be obtained at much higher limits ($750 million to $2 billion). It contains broader language and does not depend on TRIPRA certification. It can be locked in for three-year periods and can be tailored for covered locations outside the U.S. and Canada that are more volatile. The coverage grant can be extended to include acts of domestic or international sabotage and political violence perils coverage (war, civil war, strikes, riots, civil commotion, malicious damage, insurrection, rebellion, revolution). Importantly, these policies can provide business interruption and business expense as an included cover, along with loss of rental income coverage.
For example, as notorious and profoundly disruptive as the Boston bombings were in 2013, the Obama administration was unable to certify the bombings under TRIPRA because the claimed losses did not exceed the certification threshold. This is despite the fact that the president described the attack as domestic terrorism. According to an article in Insurance Journal, 207 property/casualty claims were filed related to the Boston bombings; 84 have been settled for a total of $1.2 million, and 76 have been closed without a payment. Many of the local businesses and hotels did have TRIPRA coverage, but the aggregate did not reach $5 million for a certification determination. Consider the problems associated with a series of coordinated attacks as in Paris in January 2015 and how such an investigation, if effectuated over a seven- to 10-day period, might paralyze our hypothetical construction site and create losses that might flow from revisions to the construction schedule. Consider further the problems associated with determining whether force majeure clauses would deem terrorism events to be excusable delay.
Traditional TRIPRA coverage may be wholly inadequate for these unique construction industry concerns, especially if the certification threshold is not achievable. Most importantly, stand-alone policies can respond to civil commotion or unrest caused by a non-certified event that does not necessarily cause dramatic physical damage to the construction project. Traditional business interruption coverage under a commercial property policy depends on finding direct, related physical loss; likewise, actions of a civil authority in the absence of direct physical damage in the area covered by any declaration may not be covered and would not be effective at capturing economic loss associated with a shutdown of public access to a construction site following a terroristic event proximate to the site or impacting the site.
Marsh has tracked the TRIPRA uptake rate for the construction industry and has noted that it reached 58% by the time President Obama signed the 2015 reauthorization. It is noteworthy that, in 2003, construction industry uptake rates were half that of today. The highest region for purchase was the Northeast at 72%, owing presumably to the concentration of high-value infrastructure and property targets in major Northeast cities.
Premium rates also have remained generally steady for terrorism coverage, the Marsh 2016 Terrorism Risk Insurance Report found. Companies with total insured value of less than $100 million paid a median of $53 per $1 million of coverage in 2014 to $57 per million in 2015. Their terrorism premium rates remained significantly higher than those of larger companies ($100 million-$1 billion in size), which could be expected to pay $15 to $25 per $1 million. It is important to note that median premium in the construction industry is highest of all measured industries, topping out at $68 per million in 2015.
The construction industry will continue to face unique terrorism risks. These risks include physical risks and, now, emerging cyber threats. Given the frequent engagement with public infrastructure development, targets such as our hypothetical power station could experience both extraordinary physical damage and resultant economic harm. Failure to address terrorism risk could induce a life-threatening or fatal corporate blow should it be determined that the event itself is uninsured either because the event is not “certified” or the non-certified loss limitations prevent coverage for the construction policyholder.