Government Terrorism Insurance: Déjà Vu(Doo)?

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

In an Oct. 10 letter to President Bush, leading financial services executives wailed, “The U.S. economy cannot possibly recover without the full availability of insurance.” Treasury Secretary Paul O’Neill surveyed the market for lemmings and told the Senate Banking Committee last October, “We’re facing a cliff. … Leaving this problem unresolved threatens our economic stability.” Without government terrorism insurance, no buildings will 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 commercial office space would adjust. Last month, Congress adjourned after it couldn’t agree on a terrorism insurance bill. Now, the Bush administration is desperately dredging the political harbor, looking for any evidence of insurance-related economic dislocation. 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. 11 to “sell insurance to corporate customers at sharply higher rates ….” The chief executive of XL Re, a Bermuda insurer, told a recent industry conference, “The opportunity out there is tremendous.” The New York Times reported on Dec. 17 that the industry looks so attractive that new money is pouring in to start new companies and to expand existing operations concluding, “…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 state regulators allowed them to do so. Business life went on. “No Terror Insurance, But Lenders Still Lending” the American Banker reported on Jan. 7. “No one has come to us and said this is curtailing lending,” observed David Gibbons, the deputy comptroller for credit risk at the Office of the Comptroller of the Currency.

Fleet Boston Financial Corp. is requiring terrorism insurance “for only a small number of loans,” according to John Mastromarino, executive vice president for risk management. As one lender observed, “Why would a bank want to be stuck with a half-finished building by calling in a loan?”

Bankers are requiring terrorism coverage for some projects and it is expensive. Again to quote Mr. Mastromarino, “We have a half-dozen deals where we are requiring terrorism insurance. They’ll get it. It’ll cost them more. But in our opinion it will not be so prohibitive as to hurt the economics 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 terrorist targets? Risk managers interviewed for the American Banker article said that projects like “a strip mall near a nuclear plant,” for example, “could be too small to absorb the high cost of terrorism insurance.” Should Congress enact a program to insure that Homer Simpson doesn’t have to bring his lunch to work?

Even in large cities like Chicago, where higher insurance premiums are being passed along to commercial tenants, insurance executives and property owners told the Chicago Sun-Times last fall that “insurance is a relatively small expense that isn’t likely to send companies packing for the perceived safety of suburbs or smaller towns.” According to Robert Hartwig, chief economist at the Insurance Information Institute, “Even with the increases, in many cases [building owners] will be paying no more than they were five years ago.”

Free markets work best if they include all costs and benefits to market participants. No one likes the added costs and anxieties created by the Sept. 11 attacks, but we can’t pretend they don’t exist or that the government can magically make them disappear. Our markets for risk are not failing, 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 not involve greater entanglement in insurance markets. By improving national security, government can reduce the risk of terrorism and its costs. Success on that front would go a long way toward reducing the uncertainty we see now in insurance markets. Better security, not more subsidies, remains the best response to the events of Sept. 11. Markets can handle new risks, as long as politicians don’t overreact to imagined ones. Change the real risk. Don’ t hide its cost.

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