Analysis of the FIO Report on TRIP and Small Insurers

With the reauthorization of the Terrorism Risk Insurance Program (TRIP) in 2015, Congress mandated the Department of the Treasury to develop rules concerning the participation of captive insurers and other self-insurance arrangements in the program. At the same time, Congress also required the Treasury to conduct a study of small insurers participating in the program and identify any competitive challenges these small insurers faced.

The Treasury remanded the duty of conducting this study to the Federal Insurance Office (FIO), which released its report, Study of Small Insurer Competitiveness in the Terrorism Risk Insurance Marketplace, in June. This article explores the decision not to include captives as "small insurers" and looks at some of the conclusions from the recently conducted FIO study that captive insurers should understand and discuss.

In early 2016, the Treasury exposed a set of proposed rules concerning the implementation of TRIP. The rules included a requirement that all insurers participating in the program provide data to the department, which would allow the Treasury to review the costs and effectiveness of TRIP. The exposure draft also sought comments on the extent to which captive insurers participated in providing insurance in TRIP-eligible lines. Comments on this question were received from a number of associations, including Risk and Insurance Management Society, Inc. (RIMS), and the Self-Insurance Institute of America, Inc. (SIIA). 

RIMS asserted in its letter, "Captive insurers are significantly involved in TRIP-eligible lines of insurance, particularly with respect to nuclear, chemical, biological, and radiological (NCBR) risks. In fact, without access to coverage through captive insurers for NCBR risks, many companies would have to go without insurance coverage for those risks."

In response to whether captives should be treated as small insurers, RIMS commented as follows.

In justifying the exemption, FIO states that "captive insurers typically insure only the exposures of corporate parents or of other related policyholders, ... [so] the establishment of a captive insurer is a risk management decision that is not compelled by TRIP, and the corporate parent or other source of strength of the captive insurer is ultimately positioned to manage any potential risk presented to the captive by its participation in TRIP." The assumption about source of strength may not be applicable to all captive insurers. Some corporate parents of captive insurers are themselves small, which would diminish the source of strength available to the captive insurer held by smaller parents. Consequently, differentiating between small captive insurers and other small insurers based on the source of strength argument is not supported, so the captive insurer carve out from the definition of small insurer is questionable.

SIIA provided a detailed response as well, stating as follows.

Captive insurance arrangements provide a valuable risk transfer mechanism within the current terrorism risk lines of insurance. In particular, captive insurance arrangements are being used to fill gaps in an insureds' risk programs, which is often times necessary due to the prohibitively high premium rates for commercial insurance products, or insufficient capacity among commercial insurers to provide terrorism risk-related insurance coverage to public and private entities. In certain instances, captive insurance plays a critical role in the provision of TRIP-eligible coverage, including for "trophy risks...." By way of example, the power generation industry utilizes captive insurance arrangements to provide coverage for certain power generation assets (i.e., power generation plants, switchyards, and other assets).

In the final rule, the Treasury chose to exclude captive insurers under the definition of small insurers, while at the same time subjecting captive insurers to the data collection mandated on the reauthorization.

Small insurer [emphasis in original] means an insurer (or an affiliated group of insurers ...) whose policyholder surplus for the immediately preceding year ... is less than five times the Program Trigger amount for the current year and whose direct earned premium for the preceding year is also less than five times the Program Trigger amount for the current year. An insurer that has not had a full year of operations during the immediately preceding calendar year is a small insurer if its policyholder surplus in the current year is less than five times the Program Trigger amount for the current year. A captive insurer [emphasis added] is not a small insurer, regardless of the size of its policyholder surplus or direct earned premium.

Regardless of whether captive insurers qualify under the definition of "small insurer," the conclusions reached in the FIO report are worthwhile reading. Captive managers and boards should look at the results and ask themselves whether any of the issues raised in the report are true for their own entity. Forewarned is forearmed, and while we all hope that we never reach the program trigger, understanding the consequences in such an event is critical.

CONCLUSION FROM THE FIO REPORT

Small insurers are a significant component of the market for terrorism risk insurance in the United States.

While the market share of small insurers subject to the Program has gradually decreased over the period where the Program Trigger remained constant, this decline is generally consistent with the analysis of market share information for P/C lines of insurance not subject to TRIP. There has also been a decline for small insurers in the premium received and policyholder surplus in TRIP-eligible lines of insurance. Small insurer market share, premium, and policyholder surplus will potentially increase in the future because of the annual increase in the Program Trigger through 2020.

Based on the 2017 TRIP data call, small insurers charge less than non-small insurers for terrorism risk insurance, and are more likely to charge no premium for such coverage. Additionally, the take-up rate for terrorism risk insurance of small insurers' policyholders is lower than the take-up rate of larger insurers' policyholders. Small insurers tend to operate on a regional basis, in fewer states than larger insurers, and their insurance writings are more heavily concentrated than those of larger insurers (such that they have a larger share of the overall market in those lines) in the commercial multi-peril and workers' compensation lines of insurance.

This Study is not making conclusions regarding the impact of the mandatory availability requirement on the market competitiveness of small insurers. Treasury will continue to evaluate whether the mandatory availability requirement is having any market impacts on small insurers in the TRIP-eligible lines of insurance.

The Program Trigger requirement can operate to prevent reimbursement for small insurers that sustain terrorism losses in excess of their Program deductibles. Small insurers may purchase private reinsurance to avoid this potential challenge. The 2017 TRIP data call indicates, however, that most small insurers do not purchase sufficient private reinsurance to address this issue. Although small insurers may otherwise be protected by the existence of losses of other insurers that satisfy the Program Trigger, this will vary from case to case, depending on the size of insured losses arising from the act or acts of terrorism.

Terrorism risk insurance must be provided as a component of workers' compensation insurance under state law. Therefore, this potential risk for small insurers of unreimbursed losses in excess of Program deductibles could be more pronounced in connection with this line of insurance. Small insurers have a larger share of this market, which is subject to potentially unlimited losses and significant aggregation risks.

Source: Study of Small Insurer Competitiveness in the Terrorism Risk Insurance Marketplace, Section V "Conclusion," Federal Insurance Office, US Department of the Treasury, June 2017.