Fifth public hearing of the National Commission on Terrorist Attacks Upon the United States

Statement of John Degnan to the National Commission on Terrorist Attacks Upon The United States
November 19, 2003

INTRODUCTION / OVERVIEW:

Good Morning Governor Kean, Vice Chairman Hamilton and members of the Commission. My name is John Degnan, and I am Vice Chairman of The Chubb Corporation. I commend you for convening this public hearing to explore “Private/Public Sector Partnerships in Emergency Preparedness.” It is an honor to testify before you this morning.

Chubb is a global property-casualty insurance company that has provided business and personal insurance for over 120 years. One of our specialties is insuring financial institutions – banks, brokerage firms, investment houses and the like. As such, it will come as no surprise to you to learn that we were one of the largest insurers of the World Trade Center and its tenants, and one of the largest insurers of businesses, homes and automobiles in Lower Manhattan as well. Responding to catastrophic events swiftly, fairly, and with compassion is something Chubb has always done well. But never before was Chubb’s mettle tested so thoroughly as on 9/11.

In response to your November 12 letter, I would like to focus my remarks on our experience in the aftermath of the attack, the current climate for terrorism insurance, as it has been influenced by the Terrorism Risk Insurance Act of 2002 (TRIA), and the challenges we in the risk management business and our insureds will face when TRIA expires. This final point includes an evaluation of options to meet those challenges.

In essence, 9/11 revealed a new magnitude of man-made, catastrophic and, absent a federal backstop, uninsurable peril, one which remains very hard to evaluate. We continue to believe, based on experience, that the private marketplace is unable to manage terrorism risk on its own because such risk is neither predictable nor accidental. Moreover, we believe that, philosophically, protection of the public and the economy from the effects of foreign attack is a fundamental responsibility of the federal government. Accordingly, only the federal government should bear the ultimate responsibility for making the economy and body politic whole again if there is a future attack.

CHUBB’S RESPONSE TO 9/11:

The attacks of 9/11 taught us that our response must come quickly, but in several phases: first, reacting quickly and compassionately to the human suffering; second, analyzing the legal and financial implications of the situation; third, identifying affected policyholders; and fourth, implementing the claims process and other logistical challenges to deliver the promise of our insurance product.

As seasoned underwriters and claims adjusters, our staff is trained to analyze catastrophic situations in a professional, somewhat detached way. But the circumstances surrounding the attack on the World Trade Center, the Pentagon and Flight 93 profoundly affected the emotions of even the most jaded insurance professional on that terrible, incomprehensible September morning.

There was immediate concern for Chubb employees and family members who might have been meeting with customers or brokers in the twin towers, or who might have been passengers on any of the four hijacked planes. There was also concern for agent and broker colleagues whose firms were located at the World Trade Center. There was at the same time frustration about the logistical nightmare of dispatching a “swat team” of claims adjusters to Ground Zero with all air travel grounded and movement in and around Lower Manhattan severely restricted. Finally, there was the staggering task of calculating the financial ramifications of the property insured loses of our policyholders, both on their lives and businesses, as well as the effect on Chubb.

All of these thoughts went through our minds as the senior management team convened in our boardroom upon hearing the news of the attack.

Of course, it was difficult for any of us to focus our attention on the job at hand as we watched the tragedy unfolding before our eyes on television. Nevertheless, by 9:30am that morning – thanks to the dedication and experience of our staff and access to some valuable technology tools – we were able to estimate the extent of our property exposure. That information enabled us to project our property losses, exclusive of business interruption, within hours of the tragedy, making Chubb the first insurance company to do so. Quantifying the loss quickly, we believed, helped prevent possible market panic about the solvency of the insurance industry and its ability to meet its obligations.

Chubb senior management then set about perhaps its most important task: a detailed analysis of whether or not the “war exclusion,” common language in all U.S. insurance policies, would apply, in which case the monumental property losses would not be covered. We balanced the legal, moral and business ramifications of such an analysis, and determined that the war exclusion did NOT apply – a decision that allowed Chubb to publicly state our coverage position ahead of any other insurer. We believe that in doing so we influenced the conclusion later reached by the rest of the insurance industry.

I’d like to call the Commission’s attention to a passage in a recent book that explores how America confronted the September 12 era entitled After: How America Confronted the September 12 Era, by Steven Brill, where he underscores the pivotal nature of Chubb’s decision not to invoke the “war risk” exclusion.

“…The lawyers… at Chubb’s headquarters in New Jersey… look[ed] not only at the case law and what the Chubb policies said, but also at how the White House and others in Washington had described the attack as an act of war. According to White House Counsel Alberto Gonzales, President Bush was told about the possible insurance ramifications of calling this an act of war, but he insisted on ‘calling it what it was.’ Another White House staffer says that the President declared he was going to call it war, and that they should ‘work on’ the insurance companies…

“Thanks to O’Hare [Chubb’s former CEO], they didn’t need to be worked on. At 3:00pm he came into the… conference room… full of lawyers and executives… No one said that coverage should be denied outright. But there were strong arguments either to delay and do nothing until another insurer announced something, or to issue what in the insurance industry is known as a ‘reservation of rights,’ which meant that…it might pay out now but later seek return of the payments if the facts and law warranted that…O’Hare was sure of one thing, which was that Chubb’s history and culture were based on being the company that always was first and most eager to honor its policies… Now he was presented with a once-in-a-lifetime test of this Chubb credo.

“For us to have done anything different now, for us not to have taken the lead,” he explain[ed], “would have been bad business. It would have erased everything we have stood for all these years. And it would have been wrong.” O’Hare told the staff to issue a press release… announcing that Chubb was honoring all claims and was going to start writing checks within a day. When the release came out the next morning, it was not a moment too soon. Just before it was issued, an insurance industry newsletter… speculated that insurers could invoke the act of war exclusion, and reporters were already calling around to insurance companies asking what they intended to do. The Chubb announcement ended that speculation, because it was soon followed by Chubb’s competitors saying they, too, were prepared to honor all claims.

“The act of war insurance question, sa[id] White House economic policy advisor Larry Lindsey, was an issue that, if left unanswered, could have really caused a panic. ‘We deserve no credit for solving it’ [said Lindsey]. ‘We hadn’t gotten to it yet.’”

Now as you might imagine, in the days and weeks following September 11, our staff was repeatedly stretched to its limits, at every level in virtually every department. I’d like to share just a couple of anecdotes to illustrate Chubb’s response to the tragedy, and why I have never been prouder of our organization and its employees than I was during that time:

• Our workers compensation adjusters had never before experienced the number of workplace deaths they faced as a result of 9/11. Typically, a work comp adjuster handles one or two workplace fatalities a year. Here, we were facing over 900 death claims alone, apart from injuries. Instead of waiting for a family member to call us to make a claim, we vastly simplified the claim process and decided to reach out to them to let them know help was available. As a result, the State of New York Workers Compensation Board Chairman praised our outreach efforts – a rare but welcome statement of support. One adjuster’s experience will give you an idea of what the entire work comp claim team faced:

  [Quote]: “The first few days were the hardest… I cried with some of the families over the phone. One father refused to believe he lost his daughter. Convinced she would return, he invited me to her welcome home party. As difficult as it was, I wanted to make sure this father… understood the benefits and I wanted them to get the money they were entitled to as soon as possible. I knew I was representing Chubb at its finest moment. It was an honor to be part of this team…”

• While our work comp claims team was reaching out to the families of 9/11 victims, our property catastrophe team was strategizing how to get close enough to Ground Zero to estimate property losses both at the Trade Center and in the surrounding area – and start contacting customers. Finding adjusters to staff the team was not difficult. Many volunteered within minutes of the attack. While most of the initial team was drawn from our midtown Manhattan, Long Island and New Jersey offices, others drove in from across the country to help. Within a week, we handed the first check – for $30 million -- to a customer, most of whose employees were lost in the World Trade Center.

• Several prominent insurance agencies and brokerage firms had offices in the World Trade Center and surrounding area. In addition to a heavy loss of life – 300 from Marsh & McLennan and 200 from AON, for example – files, records and equipment were destroyed, leaving these firms unable to contact their customers, let alone verify a loss inventory – since in so many cases, there was no inventory left to inspect. Even while dealing with the deaths of industry friends, colleagues and business partners, we offered our own offices in New York and New Jersey to displaced agents and brokers, so they could help their customers process claims – whether they were Chubb customers or not. This kind of teamwork and partnership and trust illustrates our desire to help in whatever way we could to restore some semblance of normalcy to the insurance claims process.

I would now like to call to the Commission’s attention the concern by the President and the Congress regarding the industry’s ability to pay the claims stemming from the events of 9/11, and their response to the need for future preparedness.

ADMINISTRATION / CONGRESSIONAL RESPONSE:

Within two weeks of the attack, the House Financial Services Committee convened a hearing to explore the financial health of the insurance industry, since there was significant concern and speculation about whether or not the industry could afford to pay claims resulting from a catastrophe that some, in the days following the attack, projected would ultimately cost upwards of $70 billion.

In his testimony, Chubb’s CEO reiterated Chubb’s decision not to invoke the war exclusion and reassured the Committee that Chubb would be able to pay its claims, prompting Committee Member Paul Kanjorski of Pennsylvania to remark that Chubb’s action was [Quote], “one of the most patriotic commercial activities undertaken during the entire tragedy.” Mr. O’Hare also cautioned that insurers alone would not be able to absorb another event comparable to 9/11, that another terrorist attack of the same or greater magnitude could cripple the insurance industry and the American economy. He urged Congress to adopt some type of private/public partnership to assure adequate insurance capacity for this new and potentially infinite risk, e.g., some type of federal backstop for terrorism insurance.

The model initially suggested was based on the “Pool Re” mechanism used in the United Kingdom and nine other countries whereby insurers jointly pay into a fund to be used to pay claims in the event of a terrorist attack, which in turn is reinsured by the government – a concept that was born in the era of IRA bombings, Red Brigade attacks, and similar terrorist activities in the 1980’s.

The U.S. Treasury, and certain Members of Congress, were uncomfortable with the Pool Re concept because it required the federal government to reinsure a private terrorism risk pool. Because insurance is primarily regulated by the states, it was believed that there was insufficient expertise in Treasury to, in essence, operate a reinsurance company. Consequently, the TRIA concept was embraced, basically a federal “backstop” using individual company and industry-wide retentions. It is worth mentioning here that the insurance industry sought no bailout of its September 11 losses; they would be paid – every dollar due. Instead, it sought prospective relief only.

Creating TRIA was a laborious and occasionally acrimonious process. Despite the obvious need, certain congressional leaders believed that the federal government should have no role in covering terrorism catastrophe risk. In fact, it took repeated direct intervention by the President to ultimately achieve passage. Nevertheless, after many months, and numerous permutations, the Terrorism Risk Insurance Act [TRIA] was signed into law in November 2002.

THE TERRORISM RISK INSURANCE ACT:

TRIA directs the U.S. Government to provide a financial backstop to insurers if certain types of terrorism losses exceed specified per-company deductibles. In addition, there is an industry-wide deductible based on repayment to the Government. In 2003, the first full year of the program, the per-company deductible is 7% of the company’s direct earned premiums for covered commercial property and casualty lines. This deductible rises to 10% in 2004, and 15% in 2005. Once these thresholds are exceeded in a certified event, the Government will provide reimbursement totaling 90% of insured losses up to a maximum of $100 billion.

The legislation imposes a number of regulatory requirements on insurers including the requirement to “make available” terrorism coverage for acts covered by TRIA during the first two years of the program. Treasury has the option to extend the “make available” requirement to the third year of the program. Additionally, as indicated, the industry as a whole has a substantial repayment obligation should a “certified act of terrorism” occur. For year one the repayment is required up to $10 billion. This requirement increases to $12.5 billion in the second year and $15 billion in the third year. Accordingly, since this payback requirement is for the entire industry, some insurers that do not receive the Government payments under TRIA nevertheless would incur repayment obligations.

There is general agreement that, at least as it is operating in its first year, TRIA provides some level of solvency protection for insurers. Nevertheless, the program has some significant shortcomings.

• Of most concern is that the per-company retentions are too high. Before 9/11, for example, when an insurer looked at a workers compensation risk for a financial services provider, the maximum probable loss of such a firm was relatively low compared to other, more dangerous lines of work. After 9/11, however, even a moderate-sized financial services company can face a maximum risk of more than half a billion dollars. So even under TRIA, each individual risk has a maximum probable loss of up to the per-company deductible, and insurers continue to be faced with staggering potential losses.

• In addition, TRIA does not effectively prevent states from pre-empting Federal law. Because, for example, insurers are required to provide insurance for fire following a terrorist act in 26 states, we are forced to apply inconsistent levels of product and service for our multi-state customers.

• Finally, unlike Pool Re, TRIA is voluntary, and as a result, policyholders are experiencing the effects of adverse market selection. The only way insurance can work is if the fortunate many take care of the misfortunate few. Because terrorism presents unique risk management issues and concerns, policyholder participation in a terrorism insurance arrangement should be compulsory.

TRIA does have basic value in that it provides some solvency protection for the insurance industry. The major impact of TRIA expiration will be the solvency threat to the insurance industry. Nevertheless, I’d now like to address the challenges the marketplace will face in trying to manage terrorism risk after TRIA expires, and the political prospects for TRIA extension, beginning with the very real concern regarding insurer solvency.

POSSIBLE ALTERNATIVES TO TRIA:

TRIA will expire December 31, 2005, but the threat of catastrophic terrorism risk will remain. The expiration of the current TRIA program will exacerbate the solvency challenges faced by insurers. To give this issue some context, consider that currently the United States property/casualty industry has approximately $300 billion in surplus – roughly half that figure represents homeowners and automobile insurance, leaving approximately $150 billion to pay for all types of commercial insurance losses. Should another $70 billion event occur, the economic consequences would be significant to say the least and would seriously jeopardize the financial stability of the industry. And I think you would agree that, were the insurance industry to go insolvent, the economic reverberations would be felt throughout the world.

The insurance losses associated with the World Trade Center attack were huge and unprecedented, yet they could have been substantially larger if, for example, the attack had occurred a few hours later when more people were in the towers, the planes hit a lower floor, or even less time were available for evacuation. Moreover, the consequences for the primary insurance industry in the future would be far, far greater than 9/11, because private reinsurance for terrorism generally, and nuclear, biological, chemical, and radiological risk in particular, remains largely unavailable.

Accordingly, some governmental program is certainly needed. Currently, the industry is looking at a variety of options, including: a Federal reinsurance program; combination of regulatory standards for terrorism risk and Federal reinsurance; a statutorily created terrorism reinsurance pool; a workers compensation only backstop; tax deduction for terrorism reserves; Federal terrorism reinsurance bonds; state based solutions; and private sector solutions.

Unfortunately, each option is, in some way, fatally flawed. Given the current reluctance of many to extend TRIA, it’s doubtful that the Administration and Congress would seriously consider a Federal terrorism insurance program, despite the fact that nine countries already have such a program in place.

The current system of regulatory standards and Federal reinsurance might be suitable for ultra-high-risk facilities, such as nuclear reactors, chemical plants, biological plants, telecommunications and cyber infrastructure. However, our attention cannot be limited to these exposures. Terrorists most often strike at soft targets in an attempt to disrupt everyday life. An effective federal terrorism insurance program therefore must also address the exposures presented by high profile, and to a terrorist, highly desirable, targets like sports arenas, universities, shopping malls, day care facilities, and hospitals.

And while those soft targets are perhaps the most “emotional” risks, the greatest terrorism threat to the insurance industry’s solvency is workers compensation. Inconsistent state regulation limits insurers ability to effectively respond to workers compensation exposures. It would, frankly, benefit the insurance industry and all who rely on it if TRIA were improved and extended – if only for workers compensation. But a truly effective federal program must address other lines of insurance as well.

The tax deductibility of terrorism reserves creates adverse budget scoring implications, given the growing Federal deficit. The TRIA bill, originally approved by The House Financial Services Committee, had such a provision in it. But it was stripped out by the Ways and Means Committee.

The purchase of Federal reinsurance bonds would do little in the short term to build capacity. These bonds would likely have fairly low interest rates and restrict access to the funds.

State-based solutions would not be able to build sufficient capacity. Nor would they address the reality that terrorism is a national problem that must be addressed in a consistent way.

To rely solely on the private sector to solve the problem is not the right answer. The terrorism risk is too great, and the consequences too terrible, to rely only on the private sector’s ability to absorb it. Another terrorist attack is a virtual certainty. Only its manner, timing and magnitude are impossible to predict. Unfortunately, current prospects for improving or even extending TRIA are dim. The Administration has indicated it does not plan to push for extension. However, insurers alone cannot provide the coverage needed in the face of an incalculable risk. As a result, the insurance industry – and therefore the economy as a whole – remain at great risk. An effective Federal insurance program is an absolute necessity. Because wouldn’t it be a shame if it takes another terrorism tragedy on U.S. soil to do the right thing.

Thank you, Governor, for your attention and for your leadership on this critical issue. I would now be happy to answer any questions that you or any Member of the Commission might have.