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The New Reality of Risk TM Terrorism Coverage Volume V, Issue 7 September 2005 A REPORT FOR CLIENTS AND COLLEAGUES OF MARSH ON TIMELY RISK- RELATED TOPICS Volume V, Issue 7, September 2005 | 1 Terrorism Coverage and the Terrorism Risk Insurance Act On September 14, 2005, Marsh hosted a panel of experts who discussed coverage for terrorism risk in light of the Terrorism Risk Insurance Act. The following is based on that discussion. Welcome Timothy J. Mahoney, Chairman, North American Client Development, Marsh Today’s discussion will focus on terrorism insurance coverage and on the Terrorism Risk Insurance Act—TRIA. With the fate of TRIA still undecided as its December 31, 2005, expiration date looms, companies need to evaluate their terrorism exposures and be prepared for any outcome from Congress with respect to TRIA. Our panel of experts will discuss TRIA and terrorism coverage as it relates to the property, workers compensation, and liability insurance markets; the use of a captive insurer to access stand- alone capacity and/or TRIA; and the recommendation from the Council of Insurance Agents and Brokers [CIAB] to Congress with respect to the future of TRIA and proposed future strategies. Let me introduce our panel of experts: John Sinnott is vice chairman, Office of the CEO of Marsh & McLennan Companies, Marsh’s parent company. Jack recently delivered testimony at a hearing on the future of terrorism insurance before the U.S. House of Representatives. He will discuss his testimony and the CIAB’s position on TRIA. Robert Blumber is a managing director and U.S. sales leader with Marsh’s Property Practice. He is also head of its U.S. Property Terrorism Group. Bob will discuss terrorism coverage with respect to the property insurance and reinsurance markets. With the fate of TRIA [the Terrorism Risk Insurance Act] still undecided as its December 31, 2005, expiration date looms, companies need to evaluate their terrorism exposures and be prepared for any out- come from Congress with respect to TRIA.
Transcript
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The New Reality of Risk TM

Terrorism CoverageVolume V, Issue 7September 2005

A REPORT FOR CLIENTS AND COLLEAGUES OF MARSH ON TIMELY RISK-RELATED TOPICS

Volume V, Issue 7, September 2005 | 1

Terrorism Coverage and theTerrorism Risk Insurance ActOn September 14, 2005, Marsh hosted a panel of experts who discussed coverage for terrorism risk in light of the TerrorismRisk Insurance Act. The following is based on that discussion.

WelcomeTimothy J. Mahoney, Chairman, North American ClientDevelopment, Marsh

Today’s discussion will focus on terrorism insurance coverageand on the Terrorism Risk Insurance Act—TRIA. With the fate ofTRIA still undecided as its December 31, 2005, expiration datelooms, companies need to evaluate their terrorism exposures andbe prepared for any outcome from Congress with respect to TRIA.

Our panel of experts will discuss TRIA and terrorism coverage asit relates to the property, workers compensation, and liabilityinsurance markets; the use of a captive insurer to access stand-alone capacity and/or TRIA; and the recommendation from theCouncil of Insurance Agents and Brokers [CIAB] to Congress withrespect to the future of TRIA and proposed future strategies.

Let me introduce our panel of experts:

� John Sinnott is vice chairman, Office of the CEO of Marsh &McLennan Companies, Marsh’s parent company. Jack recentlydelivered testimony at a hearing on the future of terrorisminsurance before the U.S. House of Representatives. He will discuss his testimony and the CIAB’s position on TRIA.

� Robert Blumber is a managing director and U.S. sales leaderwith Marsh’s Property Practice. He is also head of its U.S. PropertyTerrorism Group. Bob will discuss terrorism coverage withrespect to the property insurance and reinsurance markets.

With the fate of TRIA

[the Terrorism Risk

Insurance Act] still

undecided as its

December 31, 2005,

expiration date looms,

companies need to

evaluate their terrorism

exposures and be

prepared for any out-

come from Congress

with respect to TRIA.

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John T. SinnottVice Chairman, MMC

John T. Sinnott is vice chairman ofMarsh & McLennan Companies (MMC),Marsh’s parent company.

Mr. Sinnott is located in MMC’s NewYork City office. He joined MMC in 1963 and served the company in a number of capacities, including seniorvice president, executive vice president,president, CEO, and chairman and CEOof Marsh. During his career, Mr. Sinnotthas been active in many of the insur-ance industry’s public policy initiatives,including those relating to insurer sol-vency regulation, the integration of thefinancial services industry, and the roleof the U.S. government in providingbackstop terrorism insurance coveragefollowing September 11, 2001.

Mr. Sinnott graduated from The College of the Holy Cross in Worcester,Massachusetts. He is a member of theboard of trustees of The College of the Holy Cross, Northern WestchesterHospital, The Risk Foundation, andRippowam Cisqua School; a director ofJames River Group Inc.; and a memberof the Federal Deposit InsuranceCompany Advisory Committee.

2 | The New Reality of Risk

� Edward Lynch is a managing director and the global practiceleader of Marsh’s Casualty Practice. Ed will discuss the impli-cations that TRIA’s future has for the workers compensationand liability insurance markets.

� Chris Varin is a managing director and senior account execu-tive with Marsh’s Captive Management Practice. Chris will discuss the costs and benefits of using captives to access TRIA and how they may change if the Act changes or is not renewed.

TRIA’s FutureJohn T. Sinnott

Timothy J. Mahoney (TJM): Jack Sinnott recently testified beforeCongress about the future of TRIA. His testimony to the House Financial Services Subcommittee on Capital Markets,Insurance and Government Sponsored Enterprises was madeon behalf of the Council of Insurance Agents and Brokers. Jack,please give us an overview of the CIAB’s position on TRIA.

John T. Sinnott (JTS): After the terrorist attacks of September 11,2001, we were all concerned about the insurance industry’scapacity to withstand another attack and, on a much broaderlevel, about the ability of businesses and individuals to take theessential business risks that keep our economy going. TRIA wasput forth as a federal backstop to provide a temporary window of reinsurance relief to help insurers manage the ongoing risk of terrorism. After becoming law in November 2002, TRIA wascritical not only for the insurance industry but also for the economy as a whole.

As I mentioned in my testimony to Congress, it is our positionthat TRIA has proven to be an unqualified success in stabilizingthe insurance markets during the past three years and has beenessential to the overall health of the insurance marketplace.My colleagues on this panel will provide some statistics on onemeasure of that success—take-up rates, the percentage of companies buying the coverage [see sidebar on page 3].

During my testimony, I emphasized the very positive trendingthat took place in take-up rates after TRIA became law. Rightafter the legislation was enacted, there was a very low take-uprate, which steadily increased over time. By 2004, the take-uprate was double that of 2003. We’ve seen further increases thusfar through 2005.

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More Companies Continue to PurchaseTerrorism Coverage

The percentage of companies pur-chasing property terrorism insurancehas increased steadily since the 2002enactment of the Terrorism RiskInsurance Act (TRIA). The followingchart shows the percentage of companies surveyed by Marsh that purchased the coverage, by industry, as of August 2005.

TJM: From your perspective and that of the CIAB, is TRIA stillnecessary?

JTS: Absolutely. If the backstop disappears, we will see amarked shrinkage in terrorism insurance availability frominsurers. And we can all recall the difficulties we had withhigh aggregations of workers compensation exposures in asingle area after September 11. I can see that situation comingback again. If the insurers don’t have the backstop of TRIA,they’re going to have to be much more selective about therisks they underwrite because they are concerned about aggregated risk in workers compensation.

TJM: What are the options going forward regarding TRIA andterrorism coverage?

JTS: As I outlined to Congress, we believe there are three optionsgoing forward:

� allow TRIA to expire;

� modify and extend the current TRIA program; or

� take a new approach to facilitate a private-market solution, atleast in part.

Letting TRIA expire at year’s end would seriously curtail terrorisminsurance availability. The second option—extending the life ofTRIA and readjusting its terms—could work as we move towarda more permanent solution. However, in my view, the modifica-tions proposed by the Treasury Department seem excessive.[Editor’s note: TRIA mandates that the Treasury Departmentadminister the temporary federal reinsurance backstop programestablished under the Act. TRIA also requires Treasury to assessthe program and report its assessment to Congress. Treasurysent its report to Congress on June 30, 2005.]

I counseled the House committee to look at this issue very carefully. Treasury proposed, for example, to increase the size ofa loss that would trigger coverage under the Act from an aggre-gate loss of $5 million to an aggregate loss of $500 million. Thatwouldn’t affect the large insurers whose individual deductiblesare already greater than that. But smaller insurers could be presented with very significant problems if an act of terrorismoccurred in which they were disproportionately involved as theinsurers and the trigger was set so high.

I also raised the issue that Congress should not be so quick to throw general liability out of TRIA because of the nuclear,biological, and chemical risks. The same thing is true for auto-mobile liability. Think about the trucking industry. I think that

Volume V, Issue 7, September 2005 | 3

Terrorism Take-up Rates byIndustry—as of August 2005

Real estate

Financial institutions

Health care

Hospitality

Technology/telecommunications

Education

Media

Utility

Public entity

Transportation

Manufacturing

Retail

Construction

Energy

Food & beverage

Source: Marsh’s Property Practice

72.5%

71.0%

66.3%

65.1%

63.3%

58.1%

57.9%

54.3%

53.4%

47.8%

41.2%

38.6%

37.5%

36.4%

28.6%

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Congress should look at TRIA very carefully before excludingeither general or auto liability.

TJM: There seems to be a lot of buzz in the industry regardingsome sort of a pooling arrangement as a long-term solution. Isthis viable?

JTS: If it’s crafted properly, I think a pooling arrangement couldbe a viable alternative. A pool could allow the insurance industryto establish the funding to handle the intermediate—and perhaps,over time, the ultimate—level of risk.

TJM: And how would such a program work?

JTS: I can speak only in generalities at this point, because thereisn’t a formal pooling arrangement on the table. However, in general terms, a terrorism insurance pool would be financed byparticipating insurers that would each deposit a predeterminedpercentage of their written premiums covered by the program intothe pool. Our view is that this would be based on all premiumlines, not just on selected policies. In the unfortunate event of aterrorism incident occurring, participating insurers would firstpay a pre-established deductible. Once the deductibles were paid,funds from the pool would be tapped.

TJM: What happens if the pool is drained?

JTS: If the pool is drained, the federal backstop would kick in upto a preset limit. Obviously, the backstop is more likely to betapped in the early years before a pool is fully developed. Thegovernment’s short-term liability would actually decrease as the pool grows. All federal backstop premiums would be paidthrough policyholder surcharges or other means.

One of the questions that I was asked when I testified was,“Could we expect that after a couple of years, TRIA could goaway?” My answer was that TRIA would have to be around forquite some time because of the large amount of money a poolwould have to build up to ensure that even the most severe catastrophe could be absorbed. But with each year that passeswithout a real event, the probability of TRIA ever being tappedwould become more remote.

TJM: Where are we today with respect to Congress’s decision?

JTS: I probably would have had a slightly more optimistic viewpre-Hurricane Katrina. In addition to the terrible impact Katrinahas had both in terms of human life and property destruction, ithas created another agenda item that Congress must deal with—

4 | The New Reality of Risk

Marsh Terrorism InsuranceReport Available

The future pricing and availability ofterrorism insurance are in question asof this writing as Congress debateswhether to renew the Terrorism RiskInsurance Act (TRIA).

With the uncertainty surroundingTRIA, it is more important than everfor companies to be planning theirstrategies for managing terrorismrisk, whatever Congress decides. Areport—Marketwatch: TerrorismInsurance 2005—has been developedby several Marsh practices to helpclients understand and address terrorism risk and their terrorisminsurance needs.

To order a copy of the report, send arequest to [email protected], orcontact your Marsh representative.

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the funding of the recovery, the dialogue on investigations, andso on. On top of that, the administration is talking about SocialSecurity reform, making previous tax cuts permanent, SupremeCourt nominations, and the budget. That’s a lot to be done in avery short time.

As I look at Washington, D.C., and TRIA, here’s what I see:

� Treasury seems to be cool to an extension unless the terms aresignificantly modified. I already mentioned some of the issues.

� In the Senate, some senators seem to be leaning towardextending TRIA for two years, then letting it expire. ExtendingTRIA would give time for alternatives. But just saying that after two years it’s gone is not going to work because, as I saidearlier, the industry is not going to be able to build up fundingthat quickly.

� The House Democrats seem to be saying, “Extend TRIA as is—possibly adding life insurance as a risk—and then work on along-term solution.” The House Republicans seem to be saying,“Formulate a long-term solution prior to extending TRIA,” andthat’s where the pooling issue comes in.

We’ve gotten some feedback from the staff of the House on a littlebit more granular level about this pooling concept, and we’ll beresponding to the issues raised. I also believe we should be talkingto some of the insurer groups—not that our interests aren’t inrepresenting the policyholders, not the insurers; but certainly, Iwould hope that 80 percent or 90 percent of the insurers and thepolicyholders would be in agreement on this issue.

My advice is: Stay tuned.

Terrorism Property Insurance Market ConditionsRobert V. Blumber

TJM: We now turn to Bob Blumber. With all of the uncertaintysurrounding TRIA, what should companies be thinking about?

Robert V. Blumber (RVB): Companies need to prepare for eitherthe expiration of TRIA at midnight on December 31, 2005, or for aTRIA extension with minor or major modifications. Under eachof those scenarios, we anticipate terrorism insurance capacity tobecome more limited and more expensive.

Many of our clients have already implemented strategies to deal with their terrorism risks. Some have opted to purchase acapacity-commitment product, which guarantees the availability

Volume V, Issue 7, September 2005 | 5

Robert V. Blumber, CPCUManaging Director

Robert V. Blumber is a managing director and U.S. sales leader withMarsh’s Property Practice.

Mr. Blumber is located in Marsh’s New York City office. He works closely with Marsh’s zonal propertymanagers, client executives, and salesprofessionals to develop and execute a property sales strategy in the UnitedStates. Additionally, he manages the U.S. Property Terrorism Group. Inthis role, Mr. Blumber and his team support property account teamsaround the country in the design and placement of standalone terrorism insurance for their clientsand prospects. He has been involvedwith large global and domestic property accounts for more than 20 years.

Mr. Blumber holds a BS in accountingfrom St. Joseph’s University in Phila-delphia and an MBA in financial management from Pace University in New York City. In addition, he holds the CPCU designation.

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6 | The New Reality of Risk

of terrorism capacity in 2006. Others have used a combination of“all-risk” property coverage, including terrorism and standaloneterrorism coverage, provided by a limited number of insurers.That being said, capacity has started to dwindle in certain high-risk areas of the country—namely, New York City, Chicago, LosAngeles, and San Francisco. Clients who have been waiting on aTRIA decision from Congress before they act might be betterserved by implementing a plan now.

TJM: Are you suggesting that taking action now is critical?

RVB: It absolutely is for those companies that have risks in majormetropolitan or other high-exposure areas. It is especially criticalwhen you consider that many “all-risk” property insurers havealready issued endorsements excluding terrorism that becomeeffective should TRIA expire and that standalone terrorism coverage for these risks has become increasingly difficult to procure due to insurer aggregation problems. I can only antici-pate that without TRIA or with a modified TRIA, this situationwould be exacerbated.

TJM: What are the implications of modifications to TRIA withrespect to the reinsurance market?

RVB: If TRIA is not extended or if it is modified, it is not realisticto expect the reinsurance market to expand its available capacityfrom where it is now—between $4 billion to $6 billion—up to thecoverage limits in the $100 billion range that may be required.Although increased pricing for terrorism insurance could attractnew reinsurance capacity, we have not seen any indication the insurance market is trending that way. An environmentwithout TRIA might help force such a trend, but there would be a significant time lag before any meaningful capacity wouldbecome available.

In summary, reinsurers have put limited capital at risk for terrorism exposures. Changes in the TRIA model will likely notchange this limited appetite. Not until the reinsurers build a confidence level on how to underwrite, model, and price for thisperil will they provide the necessary capacity to meet expectedinsurance-market demand.

TJM: Let’s talk about the current insurance-market conditions.What does the overall property terrorism insurance marketlook like?

RVB: When you speak about terrorism insurance-market condi-tions, you have to talk about both TRIA and the standalone

If TRIA is not extended

or if it is modified, it is

not realistic to expect

the reinsurance market

to expand its available

capacity from where it

is now—between $4

billion to $6 billion—up

to the coverage limits in

the $100 billion range

that may be required.

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In major metropolitan

areas with high levels

of concentrated risk,

terrorism insurance-

market capacity is more

limited and consider-

ably more expensive.

Volume V, Issue 7, September 2005 | 7

insurance market. Looking at TRIA, we see that nearly 50 percentof Marsh’s risk management and middle-market clients purchasedproperty terrorism insurance in 2004, a dramatic increase fromthe 2003 average of 27 percent. That percentage increased furtheras of August 2005, to nearly 55 percent. The purchase of propertyterrorism coverage in 2004 varied significantly depending on acompany’s total insured values. Smaller companies—with lessthan $100 million in total insured values—were much less apt topurchase this coverage.

TJM: Those are interesting statistics. What about take-up rates?

RVB: Take-up rates varied considerably among regions. Regionaltake-up rates for property terrorism insurance in 2004 were:

� 53 percent in the Northeast and Midwest;

� 47 percent in the South; and

� 34 percent in the West.

Financial institutions, real-estate firms, and health care facilitieshad the highest take-up rates, each exceeding 60 percent. It isinteresting to note that the median terrorism rate for 2004 wasessentially unchanged from that of 2003, indicating that theincrease in take-up rates was not necessarily driven by price.

TJM: Let’s look at the standalone terrorism insurance market-place.

RVB: If TRIA is not extended, the standalone insurance market isunlikely to have sufficient capacity to satisfy all of the expecteddemand at commercially viable prices. Capacity in the standaloneproperty terrorism insurance market has been relatively stable,though limited. The amount available for a specific risk can vary significantly depending on location, insurers’ accumulatedexposures, and the concentration of exposures in a given area.

Marsh estimates terrorism insurance-market capacity outside of major metropolitan areas at approximately $1.4 billion to $1.5billion. However, program limits greater than $500 million are relatively rare, due to pricing constraints. In major metropolitanareas with high levels of concentrated risk, terrorism insurance-market capacity is more limited and considerably more expensive.

TJM: Are companies purchasing terrorism insurance?

RVB: Companies are definitely buying terrorism insurance; andthey are buying it across the country, which goes against the oft-expressed opinion that terrorism is a concern only for major

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8 | The New Reality of Risk

Northeast cities. As you would expect, terrorism insurance is cer-tainly more expensive in the Northeast than it is in the Midwest,both in terms of rates and as a percentage of property premium.

Interestingly, take-up rates in key cities such as New York;Washington, D.C.; Boston; and Los Angeles do not directly correlate with premium rates. For example, Los Angeles andHouston have high premium rates but relatively low take-uprates. Conversely, Boston and Philadelphia have relatively lowpremiums but moderate to high take-up rates. The perception of risk appears to be a driving factor in the decision to purchaseterrorism insurance.

TJM: Here’s a question that I’m sure you get asked a lot: WillTRIA be extended?

RVB: That is a question I get asked a great deal and, quite frankly,one that I cannot answer.The Bush administration has not showna strong interest in extending TRIA, showing more interest inhearing about options for a permanent solution to dealing withthe risk of terrorism.

This is the challenge confronting our industry today. Can someplan be implemented by December 31, 2005? In my opinion, thatis highly unlikely. However, if the insurance industry expects thefederal government to continue this backstop, it needs to presentthe administration with some viable long-term concepts and arealistic timeline for getting a program up and running—thusreducing the government’s and taxpayers’ exposure to this risk.

Terrorism and Workers Compensation ExposureEdward T. Lynch

TJM: Let’s move now to Ed Lynch. If TRIA expires, what are theimplications for the workers compensation insurance market?

Edward T. Lynch (ETL): Workers compensation presents anextremely difficult challenge to everyone involved when it comes to terrorism exposure. This is largely because workerscompensation is controlled by the states, which have notallowed exclusions for terrorism losses.

Companies need to be aware that if TRIA expires, insurers aregoing to try to limit their exposures to high concentrations ofrisk. Some insurers may feel they have no choice but to limittheir risk accumulations by not renewing some workers com-pensation policies. It’s important to note that insurers writing

Edward T. LynchManaging Director

Edward T. Lynch is a managing directorand the global practice leader ofMarsh’s Casualty Practice.

Mr. Lynch is located in Marsh’s NewYork City office. He oversees the firm’sCasualty Risk Practice, whose morethan 2,000 members service clients’needs through technical excellenceand highly developed transactionalskills, serve the day-to-day serviceneeds of casualty clients, and areresponsible for new products andsolution development. Mr. Lynch has additional management responsi-bilities for Marsh’s EnvironmentalPractice and Workers CompensationPractice. He has been with Marshsince 1982 and has served clients andthe firm as a client executive andoffice head with senior managementresponsibility in large and mid-sizerisk accounts.

Mr. Lynch holds a BA in economicsfrom St. Francis College in New York City.

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It’s important to under-

stand that while self-

insurance can be an

appropriate approach

to satisfying the statu-

tory requirements for

coverage, it is unlikely

that it can solve the

availability issue for

clients with a cata-

strophic exposure.

Volume V, Issue 7, September 2005 | 9

multiline coverage—such as package policies—will be particularlysensitive to site-specific accumulations of risk.

TJM: What are the options at this point?

ETL: Because each insurer’s aggregation of exposures is different,we are obtaining alternative proposals for those workers com-pensation programs likely to be affected. For example, one insurerhas publicly stated it will limit its exposure to a predeterminedamount and close its books once that amount is reached. Optionsfor companies with significant exposures in areas with a largework-force population will likely be limited. This message isprobably better and more recently reinforced by HurricaneKatrina. There’s probably no more classic example of a concen-tration of risk.

TJM: Are there any alternative solutions on the table?

ETL: There are signs that the insurance industry is attempting toaccumulate capital for terrorism exposures by collecting premiumfor catastrophic exposures. For instance, the NCCI—the NationalCouncil on Compensation Insurance—has approved an endorse-ment to provide funding for some catastrophic losses, includingterrorism acts excluded by TRIA.

In the case of domestic terrorism—which TRIA does not cover—the endorsement defines an aggregate threshold of $50 millionin workers compensation losses. This is an event threshold, notan individual insured threshold. The trigger is aggregated for allinsureds subject to a non-TRIA terror event, earthquake event,or industrial accident. While many states have approved thisendorsement—which allows insurers to make a premiumcharge—there is no formal pooling mechanism behind it and,therefore, no incentive to accumulate the premiums collected.

TJM: What about self-insurance for workers compensation?

ETL: It’s important to understand that while self-insurance can be an appropriate approach to satisfying the statutoryrequirements for coverage, it is unlikely that it can solve theavailability issue for clients with a catastrophic exposure. Ifexcess workers compensation insurers are willing to offer coverage for employers with a concentration of employees,they will likely offer a specific dollar limit of insurance ratherthan statutory coverage. Clients should carefully evaluate theircatastrophic exposures based on the state benefits applicableand the number of employees exposed.

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10 | The New Reality of Risk

TJM: In the unfortunate event that an act of terrorism doesoccur, when does workers compensation apply?

ETL: Companies should be aware that the nature of an attack willdefine the implications for workers compensation coverage. If a terrorist incident is a focused attack, such as an attack on a specific business or a specific building like the World TradeCenter or the Pentagon, workers compensation is likely to apply.If the attack is a generic assault on a locale—an entire city, forexample—then, in some jurisdictions, workers compensationwill not apply. For example, if a water supply in a city is contami-nated and the entire area is affected—homes, restaurants, and so on—workers compensation may not apply even if the victimwas at work at the time.

TJM: Let’s turn our attention to TRIA and the general liabilityinsurance market.

ETL: The premium charges for TRIA coverage quoted for primaryauto liability insurance and general liability insurance havebeen relatively modest. As a result, take-up rates in those lineshave been high; although we’re starting to see them slow downa bit. Companies should be aware that the Treasury Department’srecommendation to Congress proposes excluding auto and general liability coverage if TRIA is extended beyond 2005.Companies should also be aware that some insurers are includingendorsements on auto and general liability policies to allow the insurers to change the premium if TRIA is not extended or renewed.

Our best advice is to evaluate the underwriting questionnairescarefully prior to submitting them. There are some question-naires that are very difficult to answer and that could be usedagainst the insured in the event of a loss.

TJM: Any final thoughts?

ETL: Among the important steps companies should be taking arethe following:

� Carefully analyze and understand catastrophic exposures.

� Clearly communicate to insurers any steps taken to mitigatethose exposures.

� Be proactive in exploring alternatives, particularly if renewalswill be effective in the first quarter of 2006.

� Become engaged in the political discourse on TRIA and terror-ism coverage with your congressional delegation or industry/trade group.

Companies should be

aware that the nature

of an attack will define

the implications for

workers compensation

coverage.

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Volume V, Issue 7, September 2005 | 11

Captive Insurers and TRIAChris A. Varin

TJM: We’ll now turn to Chris Varin to discuss captive insurers.First, a point of clarification: Does TRIA in its current formapply to captives?

Chris A. Varin (CAV): Yes. U.S.-based captives are insurers for purposes of the Act. This means U.S.-based captives are entitledto all of TRIA’s benefits and subject to all of its requirements.The most substantial benefit is reimbursement of 90 percent of a certified terrorism loss after a TRIA-imposed deductible is satisfied.

TJM: Can you give us an example?

CAV: Certainly. Assume a company suffers a TRIA-certified terrorism loss of $115 million and has a TRIA deductible of $15 million. The deductible varies by insurer, but it’s currently 15 percent of the subject insurer’s direct earned premium for theprior year. TRIA will reimburse $90 million in this example. Thefigure is calculated by taking 90 percent of the $100 million thatremains after subtracting the $15 million deductible. I want to emphasize that the captive, like any subject insurer, paysnothing for this protection under the existing TRIA program.

TJM: Does TRIA impose any policy-language requirement thatlimits incorporating coverage for perils such as nuclear, biological,chemical, and radiological?

CAV: The only policy-language requirement imposed by TRIA isthe requirement to incorporate certain disclosures about the protections the Act affords. Accordingly, insurers are not limitedby the Act in terms of the breadth and depth of protection offeredwithin lines covered by TRIA. I’m glad you asked about nuclear,biological, chemical, and radiological perils because they showhow such a lack of limitations in the Act has permitted insurersto manuscript policy language for their insureds that is some-times broader than is generally available in the commercialinsurance market.

Since nothing in TRIA precludes an insurer from manuscriptingpolicy language that incorporates nuclear, biological, chemical,and radiological coverage, several captive owners unable tosecure such protection in the commercial insurance market didjust that. This is one example of how captives have been used to fill gaps in available coverage, thereby creating capacity andindirectly fulfilling the Act’s objectives. It’s also worth noting that

Chris A. Varin, CITP, CPA, ARMManaging Director

Chris A. Varin is a managing directorand senior account executive withMarsh’s Captive Management Practice.

Mr. Varin is located in Marsh’sBurlington, Vermont, office. He has oversight responsibility for theongoing management and operationof several captive insurers and is amember of the new business develop-ment team. He has coordinated theformation and management of manycaptive insurers and the implemen-tation of many insurer programs,including terrorism insurance pro-grams. Mr. Varin is also a member of the Marsh team charged with tracking developments surroundingthe Terrorism Risk Insurance Act sincethe Act’s inception, including coordi-nating associated compliance insideMarsh Captive Management.

Mr. Varin holds a BS in accountingfrom Champlain College in Burlington,Vermont. He is a Certified PublicAccountant (CPA) and a CertifiedInformation Technology Professional(CITP). He is a member in good standing of the American Institute of Certified Public Accountants andthe Vermont Society of CertifiedPublic Accountants. In addition, heholds the ARM designation.

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12 | The New Reality of Risk

in guidance issued subsequent to TRIA’s enactment, the TreasuryDepartment made it very clear that while an insurer is notrequired to provide nuclear, biological, chemical, and radiologicalcoverage, if an insurer does provide these coverages, then the Actwill respond.

TJM: What’s the downside to using a captive for terrorism coverage?

CAV: Setting up a captive requires some effort in addition to theactual dollar costs. Doing so entails incorporating an entity, com-plying with certain state application and licensing requirements,and providing or contracting for ongoing management.

Ongoing management requires month-to-month interactioninside the captive owner with departments such as tax, finance,accounting, and risk management, and with outside consultantssuch as management companies, legal counsel, auditors, andcaptive regulators. Having said all that, in many situations,captives can be an excellent tool for a variety of risks, includingterrorism coverage—especially given the current provisions of TRIA.

TJM: Is it difficult to form a new captive to provide terrorismcoverage?

CAV: It isn’t difficult, but it’s not an undertaking one should enterinto without appropriate due diligence and a medium-term timehorizon. Setting up a captive generally requires about 45 days fromthe date the decision is made to the point of getting the captivelicensed and operating. It also requires certain commitments, suchas being willing to capitalize the captive sufficiently to ensure ithas adequate funds to pay a reasonably foreseeable loss.

TJM: What do you mean by adequate funds?

CAV: The amounts involved are often material, and requirementsin millions of dollars of cash or letters of credit are not uncommon.

TJM: What is Treasury’s position on captives as they relate to TRIA?

CAV: Treasury has issued cautionary statements about the appro-priate use of captives related to TRIA. Treasury statements andactions can be summarized by saying that Treasury recognizesthere are proper and improper uses for captives under TRIA. Asfar as those companies that might think of using the extra flexi-bility inherent in captives to abuse TRIA, Treasury has worked

In many situations,

captives can be an

excellent tool for

a variety of risks,

including terrorism

coverage—especially

given the current

provisions of TRIA.

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Volume V, Issue 7, September 2005 | 13

hard to convey the message that abusers may find themselveswithout the recovery they’re anticipating should they experiencea loss.

The point I really want to make is that under TRIA, captives havebeen a very good way to insure terrorism risk and further theobjectives of the Act. But it’s important to engage appropriatecaptive management, legal, and brokerage experts that can assistwith ensuring that both the requirements and the spirit of theAct are satisfied. Ideally, such arrangements should occur earlyin the exploratory stage, but certainly prior to any implementa-tion decision.

TJM: If TRIA is allowed to sunset on December 31, 2005, asscheduled, what are the implications for using a captive tomanage terrorism exposures?

CAV: If TRIA is allowed to sunset, captives participating in terrorism programs will likely recede back to their prior roles—essentially, providing a formal structure for a company to retainall or a portion of its terrorism risk or providing a conduit foraccess to reinsurance markets offering terrorism coverage.

TJM: What should companies be doing at this time regardingterrorism coverage and captives?

CAV: For companies without an existing captive or with an existing captive not yet writing terrorism coverage, it makes little sense to go beyond exploratory discussions until we havesome certainty regarding TRIA’s future.

Companies with an existing captive currently offering terrorismprotection should ensure that policies extending beyondDecember 31, 2005, are provisioned to take into account TRIA’sscheduled sunset. They should be exploring alternative programstructures now if their intent is to ultimately ensure the transferof some or all of their risk to third parties.

Companies with

an existing captive

currently offering

terrorism protection

should ensure that

policies extending

beyond December 31,

2005, are provisioned to

take into account TRIA’s

scheduled sunset.

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14 | The New Reality of Risk

Abbreviations and Acronyms in This Issue

� ARM: Associate in Risk Management

� CIAB: Council of Insurance Agents and Brokers

� CPCU: Chartered Property Casualty Underwriter

� NCCI: National Council on Compensation Insurance

�TRIA: Terrorism Risk Insurance Act

To review your organization’s needs in the areas discussed—terrorism insurance, the Terrorism Risk Insurance Act, and captiveinsurers—please contact your Marsh representative. For moreinformation, log on to our Web site, http://www.marsh.com.

Marsh is committed to delivering information about risk-relatedissues that pertain to protecting your organization. Although we have attempted to review the key topics in some detail, werecognize that you may have additional questions or concerns. Ifyou have any questions or comments about this panel discussionor any other issue, please contact your Marsh representative, orsend an e-mail to [email protected].

The comments in this report do not represent coverage interpre-tations by insurers or brokers and are not meant to discourageany organization or individual from filing a claim. The insurer,not Marsh, will determine whether coverage is available.

Editor: Tom Walsh

Managing Editor: Meike Olin, CPCU, CIC

Production Manager: Christine Reilly

Publisher: Timothy J. Mahoney

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About Marsh & McLennan CompaniesMarsh & McLennan Companies (MMC) is a global professional services firm with annual revenuesexceeding $12 billion. It is the parent company of Marsh, the world’s leading risk and insurance servicesfirm; Kroll, the world’s leading risk consulting company; Guy Carpenter, the world’s leading risk and reinsurance specialist; Mercer, a major global provider of consulting services; and Putnam Investments,one of the largest investment management companies in the United States. Approximately 60,000employees provide analysis, advice, and transactional capabilities to clients in over 100 countries. Itsstock (ticker symbol: MMC) is listed on the New York, Chicago, Pacific, and London stock exchanges.

MarshMarsh meets the global needs of its clients through a wholly owned network of more than 400 officesin more than 100 countries. In every country, Marsh combines a deep knowledge of local risk issues withthe ability to tap global insurance and capital markets for solutions tailored to client needs. Since itsfounding more than 130 years ago, Marsh has steadily built its business beyond insurance broking toencompass a full range of services to identify, value, control, transfer, and finance risk.

KrollKroll provides corporate advisory and restructuring, forensic accounting, valuation and litigation consulting, electronic evidence and data recovery, business intelligence and investigations, backgroundscreening, and security services. It serves a global clientele of law firms, financial institutions, corpora-tions, nonprofit institutions, government agencies, and individuals.

Guy CarpenterGuy Carpenter provides reinsurance broking, financial modeling services, and related advisory functionsworldwide for insurers and reinsurers.

MercerMercer provides clients with solutions linking the three most enduring dimensions of business success—business design, organizational design, and people strategy. It does this through a unique array of consulting expertise:

� Mercer Human Resource Consulting is the global leader in human-resource, employee-benefit, andcompensation consulting.

� Mercer Management Consulting helps clients achieve sustained shareholder value through innovativebusiness design.

� Mercer Oliver Wyman is a leader in financial-services strategy and risk management consulting.

� Mercer Delta Consulting works with CEOs and senior teams of major companies on the design andleadership of large-scale transformation.

� NERA Economic Consulting, the leading firm of consulting economists, devises solutions to problemsinvolving competition, regulation, finance, public policy, and business strategy.

� Lippincott Mercer, the premier corporate-identity firm, helps clients create, develop, and manage theirbrands throughout the world.

Putnam InvestmentsPutnam Investments plays a key role in the financial-planning decisions of millions of individuals and thousands of institutions. With more than 60 years of investment experience, Putnam providesinvestment-management services to more than 2,700 institutional and 401(k) clients and manages morethan 14 million individual-shareholder accounts.

Collaborative SolutionsThe companies of MMC work together to offer multifaceted client solutions. In so doing, they bring tobear a unique range of perspectives on the toughest issues confronting clients, industry by industry. Riskmanagement is the focus for many of these collaborative services. Through the expertise of Marsh, Kroll,Guy Carpenter, Mercer, and Putnam, the companies of MMC are uniquely positioned to offer clients risksolutions and advice across the full range of their strategic, financial, operating, and hazard risks.

For more information about Marsh & McLennan Companies, go to http://www.mmc.com.

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The information contained herein is based on sources we believe reliable, butwe do not guarantee its accuracy, and it should be understood to be general riskmanagement and insurance information only. Marsh makes no representationsor warranties, expressed or implied, concerning the financial condition, solvency,or application of policy wordings of insurers or reinsurers. The information isnot intended to be taken as advice with respect to any individual situation andcannot be relied upon as such. Insureds should consult their insurance advisorswith respect to individual coverage issues.

This document or any portion of the information it contains may not be copiedor reproduced in any form without the permission of Marsh Inc., except thatclients of any of the Marsh & McLennan Companies, including Marsh, Kroll, GuyCarpenter, Mercer, and Putnam, need not obtain such permission when usingthis report for their internal purposes.

The New Reality of Risk: Terrorism Coverage© 2005 Marsh Inc. All rights reserved.

Marsh. The world’s #1 risk specialist.SM

Item #: 100??? 10/05Compliance #: MA5-10486


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