Government Terrorism Insurance: Déjà Vu(Doo)?

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After the Sept. 11 attacks, property and casualty insurers said that theyplanned to stop offering terrorism coverage after Jan. 1, 2002 because theycouldn't handle the risks and costs. Bankers who make loans for newconstruction and owners of commercial buildings argued, "Without coverageagainst terrorist acts, banks will not lend to new construction insurance[and] it will be difficult to sell major projects such as new pipelines, newpower plants, [and] new skyscrapers.."."

In an Oct. 10 letter to President Bush, leading financial servicesexecutives wailed, "The U.S. economy cannot possibly recover without thefull availability of insurance." Treasury Secretary Paul O'Neill surveyedthe market for lemmings and told the Senate Banking Committee last October,"We're facing a cliff. ... Leaving this problem unresolved threatens oureconomic stability." Without government terrorism insurance, no buildingswill be built, and the economy will tank.

Back when those predictions were made, we argued that that bankers,construction customers, insurance companies, and the owners of commercialoffice space would adjust.Last month, Congress adjourned after it couldn't agree on a terrorisminsurance bill. Now, the Bush administration is desperately dredging thepolitical harbor, looking for any evidence of insurance-related economicdislocation. So, let's go to the videotape.

The Nov. 15 Wall Street Journal reported that Marsh and McLennan, the world's largest insurance broker, formed a new subsidiary just days after Sept. 11to "sell insurance to corporate customers at sharply higher rates . . .."The chief executive of XL Re, a Bermuda insurer, told a recent industryconference, "The opportunity out there is tremendous." The New York Timesreported on Dec. 17 that the industry looks so attractive that new money ispouring in to start new companies and to expand existing operationsconcluding, "...it is hard to remember a time when prospects looked better"for the commercial insurance industry.

Many insurers decided to drop terrorism coverage as of Jan. 1, once stateregulators allowed them to do so. Business life went on. "No TerrorInsurance, But Lenders Still Lending" the American Banker reported on Jan.7. "No one has come to us and said this is curtailing lending," observedDavid Gibbons, the deputy comptroller for credit risk at the Office of theComptroller of the Currency.

Fleet Boston Financial Corp. is requiring terrorism insurance "for only asmall number of loans," according to John Mastromarino, executive vicepresident for risk management. As one lender observed, "Why would a bankwant to be stuck with a half-finished building by calling in a loan?"

Bankers are requiring terrorism coverage for some projects and it isexpensive. Again to quote Mr. Mastromarino, "We have a half-dozen dealswhere we are requiring terrorism insurance. They'll get it. It'll costthem more. But in our opinion it will not be so prohibitive as to hurt theeconomics of the deal that much. When you are talking about big projects,on a percentage basis of the overall cost it is quite small."

What about small projects built near potential predictable terroristtargets? Risk managers interviewed for the American Banker article saidthat projects like "a strip mall near a nuclear plant," for example, "couldbe too small to absorb the high cost of terrorism insurance." ShouldCongress enact a program to insure that Homer Simpson doesn't have to bringhis lunch to work?

Even in large cities like Chicago, where higher insurance premiums are beingpassed along to commercial tenants, insurance executives and property ownerstold the Chicago Sun-Times last fall that "insurance is a relatively smallexpense that isn't likely to send companies packing for the perceived safetyof suburbs or smaller towns." According to Robert Hartwig, chief economistat the Insurance Information Institute, "Even with the increases, in manycases [building owners] will be paying no more than they were five yearsago."

Free markets work best if they include all costs and benefits to marketparticipants. No one likes the added costs and anxieties created by theSept. 11 attacks, but we can't pretend they don't exist or that thegovernment can magically make them disappear. Our markets for risk are notfailing, they are simply telling us news we don't like hearing. And,despite the worst instincts of politicians and special interest pleaders,those markets are working.

Government does have a positive role to play in this, but it does notinvolve greater entanglement in insurance markets. By improving nationalsecurity, government can reduce the risk of terrorism and its costs. Successon that front would go a long way toward reducing the uncertainty we see nowin insurance markets. Better security, not more subsidies, remains the bestresponse to the events of Sept. 11. Markets can handle new risks, as longas politicians don't overreact to imagined ones. Change the real risk. Don't hide its cost.

Peter Van Doren

Peter VanDoren is editor of Regulation magazine, Tom Miller is the director of health policy studies, and John Samples is director of the Center for Representative Government, all at the Cato Institute