[Senate Hearing 107-805]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 107-805
 
                        TERRORIST RISK INSURANCE
=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             FIRST SESSION

                                   ON

 HOW THE INSURANCE INDUSTRY SHOULD RESPOND TO RISKS POSED BY POTENTIAL 
TERRORIST ATTACKS AND THE EXTENT TO WHICH THE GOVERNMENT SHOULD PLAY A 
    ROLE ALONGSIDE THE INDUSTRY TO ADDRESS THESE RISKS, IN LIGHT OF 
   SEPTEMBER 11, 2001, AND HOW THESE DECISIONS WILL EFFECT INSURANCE 
COVERAGE AND PREMIUMS ON PROPERTY AND CASUALTY REINSURANCE CONTRACTS AS 
                        THEY COME UP FOR RENEWAL

                               __________

                        OCTOBER 24 AND 25, 2001

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs








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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  PAUL S. SARBANES, Maryland, Chairman

CHRISTOPHER J. DODD, Connecticut     PHIL GRAMM, Texas
TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         WAYNE ALLARD, Colorado
EVAN BAYH, Indiana                   MICHAEL B. ENZI, Wyoming
ZELL MILLER, Georgia                 CHUCK HAGEL, Nebraska
THOMAS R. CARPER, Delaware           RICK SANTORUM, Pennsylvania
DEBBIE STABENOW, Michigan            JIM BUNNING, Kentucky
JON S. CORZINE, New Jersey           MIKE CRAPO, Idaho
DANIEL K. AKAKA, Hawaii              JOHN ENSIGN, Nevada

           Steven B. Harris, Staff Director and Chief Counsel

             Wayne A. Abernathy, Republican Staff Director

                          Sarah Kline, Counsel

                         Aaron Klein, Economist

                  Stacie Thomas, Republican Economist

   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator

                       George E. Whittle, Editor

                                  (ii)




                            C O N T E N T S




                              ----------                              

                      WEDNESDAY, OCTOBER 24, 2001

                                                                   Page

Opening statement of Chairman Sarbanes...........................     1

Opening statements, comments, or prepared statements of:
    Senator Gramm................................................     2
    Senator Schumer..............................................     9
    Senator Bunning..............................................    11
        Prepared statement.......................................    73
    Senator Bayh.................................................    11
    Senator Miller...............................................    12
    Senator Stabenow.............................................    12
    Senator Corzine..............................................    13
    Senator Carper...............................................    13
    Senator Allard...............................................    13
    Senator Bennett..............................................    31

                               WITNESSES

Bill Nelson, A U.S. Senator from the State of Florida............     4
    Prepared statement...........................................    73
Paul H. O'Neill, Secretary, U.S. Department of the Treasury......    14
    Prepared statement...........................................    75
R. Glenn Hubbard, Chairman, Council of Economic Advisers.........    37
    Prepared statement...........................................    79
Kenneth A. Froot, Andre Jakurski Professor of Finance, Harvard
  University, Cambridge, Massachusetts...........................    50
    Prepared statement...........................................    81
Kathleen Sebelius, President, National Association of Insurance
  Commissioners, Commissioner of Insurance, the State of Kansas..    53
    Prepared statement...........................................    86
J. Robert Hunter, Director of Insurance, Consumer Federation
  of America.....................................................    55
    Prepared statement...........................................    94
Thomas J. McCool, Managing Director, Financial Markets and 
  Community
  Development, U.S. Government Accounting Office.................    58
    Prepared statement...........................................    99

              Additional Material Supplied for the Record

The following statement was submitted on behalf of the following 
  associations and their members:
American Council for Capital Formation, Associated General 
  Contractors of America, American Resort Development 
  Association, Building Owners and Managers Association 
  International, International Council of Shopping Centers, 
  Mortgage Bankers Association of America, National Apartment 
  Association, National Association of Industrial and Office 
  Properties, National Association of Real Estate Investment 
  Trusts, National Association of Realtors, National Multi 
  Housing Council, Pension Real Estate Association, The Real 
  Estate Board of New York, The Real Estate Roundtable, dated 
  October 24, 2001...............................................   121

                       THURSDAY, OCTOBER 25, 2001

Opening statement of Chairman Sarbanes...........................   131

Opening statements, comments, or prepared statements of:
    Senator Gramm................................................   145
    Senator Dodd.................................................   147
    Senator Corzine..............................................   151
    Senator Reed.................................................   154
    Senator Carper...............................................   155

                               WITNESSES

Leslie M. (Bud) Baker, Jr., Chairman, Wachovia Corporation, 
  representing
  The Financial Services Roundtable..............................   133
    Prepared statement...........................................   172
Robert E. Vagley, President, American Insurance Association......   134
    Prepared statement...........................................   173
Ronald E. Ferguson, Chairman, General Re Corporation, 
  representing
  The Reinsurance Association of America.........................   136
    Prepared statement...........................................   176
John T. Sinnott, Chairman and CEO, Marsh, Inc., representing
  The Council of Insurance Agents and Brokers....................   139
    Prepared statement...........................................   179
Thomas J. Donohue, President and CEO, U.S. Chamber of Commerce...   161
    Prepared statement...........................................   181
Thomas J. O'Brien, Senior Vice President of Finance and Chief 
  Financial
  Officer, LCOR, Inc., representing The Real Estate Roundtable...   163
    Prepared statement...........................................   183
Walter K. Knorr, Chief Financial Officer, City of Chicago, 
  Illinois.......................................................   166
    Prepared statement...........................................   185

              Additional Material Supplied for the Record

Statement of Steve Lehman, FCAS, MAAA, Vice President for
  Property/Casualty, Amercian Academy of Actuaries, dated October 
    25, 2001.....................................................   185
Statement of The American Council of Life Insurers, dated October 
  25, 2001.......................................................   187
Letter submitted by The Financial Services Roundtable, dated
  October 10, 2001...............................................   193
Statement of The Independent Insurance Agents of America, dated
  October 25, 2001...............................................   196
Statement of Marc H. Morial, Mayor of New Oreleans, Lousiana and
  President, U.S. Conference of Mayors, dated October 30, 2001...   197


                        TERRORISM RISK INSURANCE

                              ----------                              


                      WEDNESDAY, OCTOBER 24, 2001

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.

    The Committee met at 10:10 a.m., in room SC-5 of the 
Capitol Building, Senator Paul S. Sarbanes (Chairman of the 
Committee) presiding.

         OPENING STATEMENT OF CHAIRMAN PAUL S. SARBANES

    Chairman Sarbanes. The Committee will come to order.
    We have a number of important witnesses this morning and 
therefore, I am going to make a very brief opening statement. I 
would invite my colleagues to do the same.
    [Laughter.]
    It is just an invitation. It is a request, not a demand.
    This is the first of 2 days of hearings that the Banking 
Committee intends to hold on the issue of terrorism insurance 
in light of the attacks of September 11. Since that day, the 
Congress has been moving in a number of directions to respond 
to the challenges that has been presented.
    This Committee, I think, did a first-rate piece of work 
with respect to the money-laundering issue and we expect the 
House to pass that bill today as part of the antiterrorism 
package and it will be taken up in the Senate very shortly 
thereafter.
    Today, we examine the future availability of terrorism 
insurance coverage for American business. There are a number of 
key questions that we obviously need to address--to what extent 
did the events of September 11 threaten the availability of 
terrorism coverage? If such coverage should be unavailable, 
what impact might that have on the functioning of our economy? 
Is Federal intervention necessary to prevent disruption of the 
economy? And if so, what form should that take?
    I want to be clear at the outset that there seems to be no 
question of the industry's ability to pay the claims arising 
from the September 11 attack, and the industry has been clear 
in stating that.
    Currently, the U.S. insurance industry appears to be in 
strong financial shape and able to weather those costs. The 
question there is what is the situation going to be in the 
future?
    We have a number of witnesses with us this morning, and I 
am going to turn to them now. First, we are going to hear from 
our colleague, Bill Nelson, who spoke with me about the 
opportunity to come before the Committee.
    Of course, Bill served for 6 years as the Insurance 
Commissioner of the State of Florida and oversaw State 
insurance regulation. Of course, insurance regulation has been 
at the State level traditionally in this country, not at the 
Federal level. Another issue that arises in the course of 
addressing this issue that is before us is what would that do 
to the regulatory scheme in terms of the Federal-State 
arrangements? And that is something I think we also need to 
keep in mind.
    Bill Nelson led the rebuilding of Florida's insurance 
market in the wake of Hurricane Andrew, which was the most 
expensive natural disaster in American history.
    He will be followed by Secretary of the Treasury, Paul 
O'Neill. Mr. Secretary, we are pleased that you are here with 
us. Then we will hear from R. Glenn Hubbard, Chairman of the 
Council of Economic Advisers.
    We will conclude today's hearing with a panel of: Kathleen 
Sebelius, President of the National Association of Insurance 
Commissioners; Thomas McCool of the General Accounting Office; 
J. Robert Hunter, Director of Insurance for the Consumer 
Federation of America; and Professor Kenneth Froot of the 
Harvard University School of Business.
    Tomorrow, we will hear from two panels, one from the 
insurance industry and another from business generally. It is 
our current 
intention that hearing will be in this room tomorrow as well, 
although that could be dependent on whether the Dirksen Senate 
Office Building, where the Committee rooms are located, 
reopens.
    As we all know, the Russell Building reopened today. But 
the Hart and Dirksen buildings still remain closed while they 
complete the environmental examinations.
    Senator Gramm.

                STATEMENT OF SENATOR PHIL GRAMM

    Senator Gramm. Mr. Chairman, let me say that I do believe 
that we wrote a good money-laundering bill. I believe it is a 
prototype of bipartisanship and I want to congratulate you.
    I cannot help but notice that the last time we were in this 
room together was the Financial Services Modernization 
Conference, and that all turned out well.
    [Laughter.]
    Chairman Sarbanes. Much to the surprise of many.
    [Laughter.]
    Senator Gramm. But not to the surprise of us.
    [Laughter.]
    Let me say on this issue, it is easy to frame the 
parameters, but making decisions on those parameters becomes 
more difficult. It is clear the Administration believes, and 
most observers believe that, ultimately, we are going to build 
the cost of terrorist insurance into the rate structure of the 
American insurance system.
    I believe it is also believed that 2 or 3 years from now, 
we will have much better safeguards than we had on September 
11. The basic question that is being debated so far as I am 
aware, there may be people with other ideas that we have yet to 
hear from, is how do we make this transition to building this 
new risk into the base? The question it seems to me boils down 
to what is going to happen on December 31, when current 
insurance policies expire?
    Some question has been raised about the ability of 
insurance companies to bear risk, say, if I were the Hartford 
and I wanted to insure, or I was asked to insure the John 
Hancock Building. It seems to me that it is important for us to 
remember that there is a reinsurance market. It is one of the 
most active insurance markets in America. It is long-standing. 
It is common policy for insurance companies to lay off part of 
their risk.
    Even before September 11, if a company was going to insure 
the John Hancock Building, they probably would have laid off 
part of that risk, either through a syndicate like a bank where 
you have a loan that is so big that the capital of the bank 
will not allow you to make the whole loan.
    You can either do it through a syndication or you could 
actually have a lead bank go out and lay off part of the loan 
with other banks. I have no doubt that this would happen. The 
question is what would the price be, and how quick would the 
learning curve be in terms of this insurance?
    The idea that somehow we have to have a Government-
sanctioned, Government-monopoly insurance pool is totally alien 
to my thinking and I see that, from my personal view, as a 
nonstarter. The question is, how do we get into the system?
    I have no doubt that the Administration's proposal would 
work. The question I have, however, and I think it is a real 
question, is if you start off with the Federal Government 
covering 80 cents out of the first dollar of exposure, so you 
do not have massive pressure to set up a terrorism reinsurance 
market in the first year, there is the possibility that the 
industry would never set it up, and would simply come back to 
Congress in 9 months or a year and say, we have to have this 
continued because we cannot make the reinsurance market work.
    I personally believe that the best thing to do if we are 
going to do this is to have a threshold amount. I think it is 
debatable what it is, that the insurance industry would be 100 
percent liable for, putting pressure on them to go ahead and 
establish this market and establish this mechanism if, in fact, 
we mean for the Federal assistance to be temporary. And I do 
not know of anybody who thinks the contrary.
    These are the decisions we have to make. I do want to 
affirm that this is our jurisdiction in this Committee. This is 
about a loan and this is about guarantees. This is about 
insurance. All insurance issues are under the jurisdiction of 
this Committee.
    I would argue that when we write the bill, that it would 
probably be an amendment to the Defense Production Act. I want 
to just reaffirm and I believe, Mr. Chairman, we are doing it 
by this hearing, that this is our jurisdiction. This bill 
should be written from this Committee. And I know that there 
are other committees who have ambitions to have this 
jurisdiction, but I think we are committed on a bipartisan 
basis to see that we protect our jurisdiction.
    I am also confident that, given the experience of the 
Members of this Committee, that we could do a better job of 
writing this bill than any other committee in the Congress, and 
that it is very important that we do it.
    Thank you, Mr. Chairman.
    Chairman Sarbanes. Thank you very much.
    Senator Dodd, who has a very strong interest, as we know, 
in this issue, is unable to be with us for today's hearing. He 
is attending a funeral this morning. He has submitted a 
statement for the record and we will have it included in the 
record. Is there any other Member of the Committee who would 
like to insert a statement into the record.
    Senator Bunning. I just want to make sure that I can put my 
statement into the record.
    Chairman Sarbanes. Certainly. Well, we will turn to Senator 
Nelson.
    Bill, as I said, we are very pleased you are here. We know 
you have had a lot of personal experience in dealing with the 
insurance market and you were regarded as probably the most 
effective State insurance commissioner in the country during 
your tenure.
    We very much welcome your observations this morning.

                    STATEMENT OF BILL NELSON

            A U.S. SENATOR FROM THE STATE OF FLORIDA

    Senator Nelson. Mr. Chairman, let me say what a great 
privilege it is to serve with every one of you. It has been a 
humbling experience for me. And whatever I can bring to the 
table today, as we work through this very thorny problem, as we 
grapple with a new kind of problem.
    And I would like to begin my testimony, Mr. Chairman, by 
saying that what we ought to approach this challenge with is 
the question, how are we going to protect America's insurance 
consumers by making sure that insurance is available and 
affordable to protect them against the despicable acts that we 
have seen? That is the thrust of where I am coming from.
    Insurance we know is a crucial engine to our economy. 
Without it, the banks are not going to make loans. Businesses 
will not invest or expand. And millions of jobs would be lost 
as the impact rippled through the economy. And so, you are 
meeting today to make sure that this will not happen. But 
neither can we allow the insurance industry, Mr. Chairman to 
use the September attacks as an excuse to shirk its rightful 
role and responsibilities. Already, reinsurance and insurance 
companies are saying that they are no longer going to cover 
terrorist attacks after December 31, when about 70 percent of 
the commercial insurance contracts in the United States are 
scheduled to expire.
    Now I do not doubt that the industry's problem is a genuine 
problem. In the immediate aftermath of September 11, it is 
virtually impossible for insurers to calculate their potential 
liability in the face of possible future terrorist attacks. We 
cannot allow ourselves to be held hostage by high-pressure 
tactics of any industry.
    And I might just recall your attention to the fact of the 
mistake that I personally believe that we made in the airline 
bail-out bill where, on a Friday, we were faced with the fact 
of the following Monday, that the insurers were going to pull 
the ticket on both United and American Airlines, which was a 
real possibility.
    We acted. We acted in haste and in the process, what 
happened was that we did not get the guarantees that all of, in 
addition to the limited liability and the victims compensation 
fund, we went beyond that and did the $5 billion of grants and 
the additional $10 billion of loans. But we did not get in 
return the fact that there was going to be commensurate saving 
for consumers.
    I have been on flights where they have a monopoly. There 
were only five people on the plane and they kept the prices 
still jacked up. Nor did we get, for example, the guarantee 
that we were not going to only take care of the airline 
companies, but we were going to take care of the airline 
employees. And now, you see where we are. We cannot even get 
that up because of the filibuster.
    What I am saying is, in the haste to solve this problem, 
let us not make a mistake on something that is so important to 
keep the engine of this economy running. From our experience in 
Florida, I know that the insurance industry is more willing to 
walk away from its biggest risk and turn them over to somebody 
else. And I can give you book, chapter, and verse, if you want 
it, because when companies paid out $16 billion in claims after 
Hurricane 
Andrew slammed across south Florida in 1992, which was the 
costliest natural disaster in insurance losses in the history 
of this country, then the major players in the industry spent 
the rest of the decade trying to slip through State legislation 
that would shift responsibility for hurricane coverage to 
Florida's government and its taxpayers.
    I am not slamming the industry. I am telling you that they 
provided the necessary support in crisis and they did it very 
well under very difficult circumstances. But I am telling you 
as an insurance commissioner, I had to battle how the insurance 
industry consistently wanted to shift the risk of hurricanes 
off onto Florida's government and to its taxpayers. 
Fortunately, we headed off almost all of those efforts. And we 
fought the industry's attempts since Andrew to force 
unconscionable and ever-increasing rates on Florida's 
homeowners.
    Homeowner insurance rates are now stabilized in Florida and 
competition has returned. And that was one of the main things 
that we had to do. We had to have the Government step in 
temporarily, help nurture the private marketplace back to life, 
and then the competition started to stabilize the prices. It 
was a solution that backed up the industry if and when it had 
another mega-storm. And surely, there will be another mega-
storm. But the emergency fund that was created in Florida, 
called the Florida Hurricane Catastrophe Fund, otherwise known 
as the Cap Fund, it was created by the State and it requires 
companies to pay for most of the hurricane loss and to shoulder 
their share of the cost of major storms. And then it spreads 
the risk by building up reserves with premium dollars, not 
taxpayer dollars.
    Whatever solution that we come up with at the Federal level 
on terrorist coverage, I believe that the same principles of 
private enterprise must be applied. Government can play an 
important role in helping resolve the immediate crisis whose 
impact would be felt far beyond the insurance industry. For the 
most part, however, we should leave the business of insurance 
to the insurance business.
    As you know, there are two basic plans so far, and you will 
hear about them in detail, the White House proposal and another 
plan that seems to have broad support from the insurance 
industry. And they are still being fleshed out. We do not have 
all the details to fully judge them. But based on the 
information that has emerged, I have some major concerns. For 
example, what safeguards would be provided to protect--
correction--what safeguards would be 
provided to prohibit insurers from doing what the industry 
calls ``cherry-picking.'' That is, ``cherry-picking'' the 
safest policies, or the flip side of that is, redlining the 
others out. In other words, once Federal help is provided, what 
is to stop the companies from covering only those properties or 
businesses that are relatively safe from terrorism and leaving 
the biggest risks to someone else? And what is to stop them 
from simply passing on any of the terrorism losses they might 
suffer in the form of sudden and steep surcharges against their 
customers? Or from finding ways, in the complex array of State 
regulations, of excluding acts of terrorism from the coverage 
consumers buy on their homes, their automobiles, and their 
lives? I say that anything we do here at the Federal level must 
assume and require that companies cover the peril of terrorism, 
a peril that looms so much larger since September 11.
    Simply put, if the Federal Government's taxpayer resources 
are granted, then the terrorism peril cannot be dumped by the 
insurance industry. As I understand it, the Administration's 
plan would make the Federal Government responsible for paying 
80 percent of the first $20 billion in claims and 90 percent of 
the next $80 billion resulting from any terrorist attacks next 
year in 2002. This proposal would increase the industry's 
liability from terrorist claims in the next 2 years, but still 
cap it at $23 billion in 2003 and $36 billion in 2004, with the 
Federal Government covering all the remaining claims. I have 
strong concerns about requiring the taxpayers to assume, even 
on a temporary basis, such a large percentage of the costs, 
especially at the front end. A more responsible approach, in my 
view, would be to require the companies to cover terrorist-
related losses up to a certain level before any Federal help 
would kick in.
    In other words, the primary insurer would cover it up to a 
certain dollar retention level and above that level, the risk 
could start to shift to the Federal Government. We should not 
support any proposal involving the use of taxpayer dollars 
unless we are convinced that the insurance companies have ample 
``skin in the game.'' And of course, the risk to the insurance 
companies could be spread by them purchasing reinsurance.
    And then, under the separate industry-backed proposal, 
apparently, their proposal is that insurers would pool their 
premiums through the creation of a new Government-backed 
insurance company called the Homeland Security Mutual 
Reinsurance Company. And each participating company would 
retain 5 percent of terrorism and 5 percent of workers' 
compensation war risk, and leave the remaining 95 percent of 
each to the insurance pool.
    Well, I hold true to the belief that private market 
solutions are more desirable than Federal intervention. But if 
I understand this plan correctly, the Federal Government would 
be responsible for covering 100 percent of any claims resulting 
from terrorism next year, while the new insurance pool starts 
to build up its capital. So look at it carefully, and as this 
debate progresses, we must constantly keep in mind that 
insurance companies are well equipped to handle most large-
scale disasters.
    It is true, this is a new kind of disaster. But nobody 
thought of the possibility a decade ago of a $50 billion 
hurricane. And had 
Andrew turned one degree to the north, instead of drawing a 
bead on downtown Homestead, a relatively sparsely populated 
area that produced a $16 billion storm loss, had it turned one 
degree to the north and drawn a bead on downtown Ft. 
Lauderdale, it would have been a $50 billion insurance storm 
that would have taken down into insolvency almost every company 
in the country that was doing business in the path of the 
storm.
    The industry is recognized by many financial rating 
agencies, institutional investors, and economists as one of the 
strongest in the global economy. They have a lot of experience 
coming out of 
Andrew as a result of the near-death experience that they had 
there. Even one of the strongest companies, like State Farm, at 
the time had about $17 billion in surplus. Had that storm gone 
on one degree to the north, it would have just about wiped out 
State Farm's surplus at the time.
    The fact is the companies have learned a lot from that 
experience and between them, the property and casualty and life 
and health insurance industry now counts nearly $3 trillion in 
invested assets. And the NAIC, whose president will testify 
here later today, has estimated that the capital cushion for 
the entire industry, including the life, is more than $550 
billion of surplus to absorb unexpected downturns in the 
financial markets and adverse loss experience on its policies, 
including terrorist acts. In other words, the industry is flush 
right now with huge surpluses.
    Whatever our solution in the Congress is to this aspect of 
the terrorist crisis, we must require insurers to pay their 
fair share. And as we consider the public policy implications 
of terrorism, reinsurance. I believe we must proceed in a 
deliberative fashion. And in my view, Mr. Chairman, this is 
just one suggestion from one Member of the Senate, that means 
reaching agreement in the coming weeks because of the shortness 
of time, on a short-term, what I would argue, no more than a 1 
year or interim solution, to ensure that insurance protection 
against terrorist attacks remains available for the new year in 
2002, and then to resume our work after January 1, to develop a 
more permanent plan.
    That approach would also enable us to consider reform of 
the current system of insuring against natural catastrophe 
disasters. Despite our progress in Florida in dealing with the 
hurricane threat, the fact remains that no single State, no 
single industry, no single insurance company, could cope with 
the kind of mega-catastrophe of the big one of the hurricane or 
the earthquake located at exactly the right place because you 
are talking about in excess of $50 billion in insurance losses 
from the big one, either earthquake or hurricane.
    In lieu of the perennial debate that we have over 
establishing a Federally backed insurance pool, I have been 
intrigued by other proposals of the way that you could approach 
it, by setting aside part of the profits for a rainy day. The 
idea is to let companies develop tax-deferred reserves and 
thereby, increase their capacity to respond to catastrophic 
loss. There needs to be a lot of deliberation on this and that 
is why, when I respectfully suggest that you may want to meet 
this immediate crisis that we are facing coming at the end of 
this year, with an interim solution, and then come back next 
year.
    I know this Committee is clearly one of the ones that takes 
a keen interest in these problems, along with the Commerce 
Committee, and I look forward, Mr. Chairman, to working with 
you toward legislation, both short-term and long-term, that 
will keep our economic engines running, but also protect the 
consumers that we all serve.
    Thank you for the opportunity. I am happy to take your 
questions or comments.
    Chairman Sarbanes. Thank you for a very helpful statement.
    I might just observe that, while you are not on this 
Committee, you are a Member of the Senate, and every Member of 
the Senate will have an opportunity to deal with this 
legislation and to address this. We need to draw in as many 
opinions in terms of what ought to be done and how people react 
to the problems.
    I have a couple of questions that I want to ask and they go 
back to your experience as an insurance commissioner. Did you 
have the authority to require insurance companies to offer 
coverage for terrorism events as insurance commissioner?
    Senator Nelson. Mr. Chairman, I believe so. That question 
never came up because it was never a question of whether it was 
not to be covered. It was always assumed to be covered. And 
there was no exclusion.
    Insurance companies are very specific about what are 
excluded in the coverage in a policy. And under most 
homeowners' policies in Florida, there was no specific 
exclusion for terrorism.
    Chairman Sarbanes. Well, suppose the companies were now to 
say, we are not going to cover terrorism. Could a State 
insurance commissioner say to the company, no, you are going to 
cover terrorism. If you are going to offer a policy, the policy 
must encompass terrorist coverage.
    Senator Nelson. Were I still the insurance commissioner, I 
would try, Mr. Chairman, but I am not sure I would be 
successful.
    Chairman Sarbanes. Well, did they try to exclude hurricane 
coverage after the Florida experience?
    Senator Nelson. No. That was required by law.
    Chairman Sarbanes. By Florida law?
    Senator Nelson. Yes, as part of the homeowner's policy.
    Chairman Sarbanes. In other words, you could withdraw 
altogether from the business. But if you are going to offer a 
homeowner's policy, it had to encompass hurricane coverage.
    Senator Nelson. That is correct.
    Chairman Sarbanes. And was that the law before Hurricane 
Andrew hit?
    Senator Nelson. Yes, sir. It is called the Wind Risk.
    Now there were times which, in the history of the 
development of coverage of Wind Risk, that there were attempts 
to, for example, in high wind risk areas, such as the Florida 
Keys, a consortium of 250 to 300 insurance companies came 
together to create a pool. And that was offered as an 
alternative of covering the wind risk in that high-risk area.
    That was part of the problem when Hurricane Andrew hit, 
that they wanted to have that pool, that consortium of 
companies, cover all of the wind risk instead of an individual 
company, particularly in your high-density urban areas of south 
Florida.
    And that is where we drew the line and said that we are not 
going to let you continue to expand and get rid of your wind or 
hurricane risk.
    Chairman Sarbanes. Did your authority as insurance 
commissioner also extend to the reinsurance business?
    Senator Nelson. Reinsurance typically is not regulated by a 
State insurance commissioner or department of insurance. 
However, we would require certain data to be set forth so that 
we had some idea. But, typically, the reinsurance was not.
    Chairman Sarbanes. Anything else?
    Senator Gramm. Mr. Chairman, we have so many other 
witnesses--first of all, Bill, thank you for your testimony. I 
think it was very helpful to us. But out of respect for our 
other witnesses, I believe Bill has given us a far more 
comprehensive statement than we would have allowed anybody else 
to give, so I am not going to ask any questions.
    Thank you, Bill.
    Chairman Sarbanes. Senator Schumer.
    Senator Nelson. There is a similarity, Senator Gramm, on 
some of the things that you expressed and some of the things 
that I 
expressed.
    Senator Gramm. There are.

            STATEMENT OF SENATOR CHARLES E. SCHUMER

    Senator Schumer. Well, thank you, Mr. Chairman, and I have 
just a couple of questions for the witness.
    First, I do want to thank you for having this hearing. From 
my State of New York, it is vital that we get something done. 
And having this hearing--this is a very interesting hearing 
because we are not bouncing a proposal off, nor is it a general 
exploratory hearing.
    There is lots of division, Senator Nelson, as you ably 
brought out. And therefore, having this hearing will really 
help make up our minds on what to do and where to go to maybe 
seek a consensus. Let me just express a couple of thoughts to 
you and get your reaction to them.
    I worry that if we do not have some kind of legislative 
remedy, downtown New York will not be rebuilt, that given that 
we are at the epicenter of what happened, given that, while the 
insurance companies are clearly paying off all of the prior 
claims, that no one is going to insure in the future. And that 
may not just be for downtown Manhattan, although probably, we 
have the greatest liability or risk. But it might be for any 
new, large project anywhere, unless they can be assured of 
getting insurance.
    And so, right now, as we sit probably in a recession, we do 
not want to have it decline much further. To risk not doing 
anything because we all cannot come together on an agreement, 
could really push us much further down the economic ladder. So 
I think it is important we do something.
    I also think that we have to look at two issues--pricing, 
how do we, as you say, ensure the dense economic centers get 
coverage, a large project. This is in the future, and that is 
one thing that I guess I would like to make clear to everybody.
    We are not looking at any bail-out of the past. The 
insurance 
industry is paying for everything that happened in downtown. 
There are going to be disputes here and there. I hear there is 
one, whether it is two incidents or one incident. But, overall, 
they are stepping up to the plate and paying.
    The issue is the future. And unlike hurricanes, you had the 
most massive hurricane, but we had previous experience with 
hurricanes. And the day after the hurricane occurred, or a 
month or a week after, there were not warnings from our 
Nation's leaders--expect something else again, like the 
hurricane that occurred, the largest ever.
    And so, I am not sure the analogy exactly applies. We have 
more pricing experience with hurricanes and we also had some 
experience with how regularly such a devastating hurricane over 
a populated area would occur. We have no experience here.
    I think that we are playing with fire by saying, well, let 
us let the market see if it can solve this problem, and then 
maybe next year, we will come back. That is one issue. And the 
second issue is duration.
    The solution that I think seems to be gathering a little 
steam is let the Government come in and pay an agreed-upon 
percentage for a year to help the industry renew contracts that 
we know are coming up December 31.
    The problem is, will anyone build anything if they do not 
know what is going to happen a year later? Because these large 
projects are not of 1 year duration.
    I do agree that perhaps in 2 or 3 years, we will have a 
little more experience and a little more market experience as 
to where to go. But we do not have it now.
    I think the analogy with the Florida hurricane, while we 
certainly can learn from it, and your wisdom is going to be 
really needed by all of us because you have more experience 
with this than anybody else, but it is inexact. It is not 
precise.
    Senator Nelson. May I respond?
    Senator Schumer. Yes, I do want you to respond. So I would 
just like to know: Do you agree that the analysis is not 
precise? And what do you say, not only to my constituents in 
Manhattan, but to any large developer around the country?
    The one other point that I would make is I think we have 
some divergence of interest between the insurance companies, 
which are very concerned, as they should be, with getting those 
policies renewed come January 1. That is for existing 
buildings.
    But when I talk to real estate developers and entrepreneurs 
and everybody like that, they say that without a longer-term 
solution, they are not going to build a thing. That means 
rebuilding downtown Manhattan, but it might mean building a 
tall building in 
Detroit, Atlanta, Indianapolis, or Trenton. Banks will not give 
them the loan.
    So that is the question I would like to ask you. Not so 
much to do this for the sake of the industry, but to do it for 
the sake of the economy of the country, which is hanging in the 
balance.
    Senator Nelson. Senator Schumer, you, we, are under the 
gun. Insurance contracts that are to start 2\1/2\ months from 
now, less than 2\1/2\ months from now, they have to have 
notices sent out on cancellation, whatever the contract calls 
for. Typically, it is 45 to 60 days.
    We are under the gun right here to get something done for 
the first of the year. And what my recommendation is to you, 
that you just cannot get the long-term permanent solution done. 
It needs more thought.
    I have suggested to you that a potential solution is get 
insurance companies' ``skin in the game.'' They have a 
retention level that you all set in law that up to that level 
that they pay, and above that, that the Federal Government 
either pays or participates in whatever form you may--you will 
hear a proposal later on about loans that would be paid back 
and loans that would be like guarantees that have a direct 
pass-through to the consumer. Bob Hunter of the Consumer 
Federation of America is going to make a proposal like that to 
you. It certainly entitles your consideration of that proposal.
    I do not equate this to the hurricane risk. I am just 
telling you about the last big insurance catastrophe that we 
went through that I happened to be in the middle of the storm 
and had the responsibility as the regulator of pulling us out 
of, and want to share with you some of the things that I 
learned in the process and some of the nature of the insurance 
industry, which it will try to dump that risk if it can, when 
in fact, it is fairly robust in its health, and it is in the 
business of insuring risk. And again, we can all say that there 
is just never been a risk like this, and what is that unknown 
out there in the future?
    That is why you have to act quickly. But I am not sure that 
you can act totally comprehensively in the next week and a 
half, is what we are talking about.
    Senator Schumer. Would you agree, though, if we did no 
solution or a 1 year solution, that it would create a 
significant damper on economic growth next year?
    Senator Nelson. Well, that is a consideration--we cannot do 
no solution. I do not think we can do that. So let us find the 
delicate balance.
    Senator Schumer. Thank you, Mr. Chairman.
    Chairman Sarbanes. Senator Bunning.

                 COMMENT OF SENATOR JIM BUNNING

    Senator Bunning. No questions at this time. Thank you.
    Chairman Sarbanes. Senator Bayh.

                 STATEMENT OF SENATOR EVAN BAYH

    Senator Bayh. Thank you, Mr. Chairman. I have one question.
    Senator I agree with so much of what you said. You gave an 
excellent statement. Your endorsement of market-based 
solutions, I think all of us would agree with that. I certainly 
do. And your concern with consumers and taxpayers being at the 
heart of our focus here I think is on target.
    My question, you also mentioned at the very end about the 
unique nature of this risk and at the beginning of your 
statement, you mentioned about the impossibility of pricing 
this risk at this moment in time. Isn't that at the heart of 
the question here, which is, are we experiencing a market 
failure that puts the interests of consumers and taxpayers at 
peril?
    That, it seems to me, is really the issue, and for 
particularly large risks, bet-the-company type risks. Won't the 
companies, if you go the consumer route, build in a risk 
premium, that if the Government acts to reduce some of that 
uncertainty, can be taken out, thereby reducing the aggregate 
cost to society as a whole?
    Because the American people are going to pay for this one 
way or the other. You either pay for it through the consumer 
mechanism, which is spread through the economy in everything we 
buy, or you pay for it through the tax mechanism, in which case 
the taxpayers pay.
    The difference between consumers and taxpayers to me seems 
to get blurred at the end of the day. So how do we reduce the 
aggregate amount of risk in an inherently unstable situation, 
it seems to me, seems to be the question. And if they really 
cannot price the risk, is not there a legitimate role for 
Government to step in a market failure and try and deal with 
that?
    Senator Nelson. All very legitimate points, Senator. There 
is good news and bad news.
    The good news is that the insurance industry is clearly 
capable of taking care of the losses that occurred on September 
11. The bad news is, as you have raised the question, on a 
going-forward basis, how do you value that risk and how do you 
pay for it?
    And nobody knows what that cost is going to be in the 
future. And that is why I am suggesting that you have to create 
a formula whereby, at the outset, the insurance companies have 
``skin in the game,'' so they will not walk away, and that they 
have to cover that initial loss up to a certain level, called 
the retention level, and then you can allow the Federal 
Government to participate either in direct grants or in loan 
guarantees. And you will hear two of those addressed by Mr. 
Hunter later on.
    Senator Bayh. The final point I would make, Senator Nelson, 
and thank you for your contribution here today, is it seems to 
me we are trying to reduce as much as possible the inherent 
uncertainty in this unprecedented situation.
    And the point Senator Schumer made I think is an excellent 
one. We have economic decisions that need to be made in the 
short run that are long-economic decisions, 6 to 7 year 
investments, bank commitments, that kind of thing. And if that 
uncertainty is not reduced, these decisions simply will be 
deferred or cancelled outright. Unfortunately, we are in the 
business, of having to make decisions now to protect the long-
term interests of the economy. Some of this is unavoidable.
    Senator Nelson. Well, said.
    Chairman Sarbanes. Senator Miller.

                 COMMENT OF SENATOR ZELL MILLER

    Senator Miller. I have no questions.
    Chairman Sarbanes. Senator Stabenow.

               COMMENT OF SENATOR DEBBIE STABENOW

    Senator Stabenow. No, thank you, Mr. Chairman.
    Chairman Sarbanes. Senator Corzine.

               COMMENT OF SENATOR JON S. CORZINE

    Senator Corzine. Pass.
    Chairman Sarbanes. Senator Carper.

             STATEMENT OF SENATOR THOMAS R. CARPER

    Senator Carper. There are two Senators in the U.S. Senate 
whose names are Nelson. And they are both former insurance 
commissioners. I do not know if that has been pointed out here 
today.
    [Laughter.]
    And I like to refer, when we have one of them on hand, as 
the half nelson. And when they are both present, as to what is 
referred to as the full nelson. But the half nelson is better 
than no nelson.
    So thank you for being here.
    [Laughter.]
    One quick question. You have referred a couple of times to 
the financial health and strength, underlying the insurance 
industry. I just want to ask you to expand on that, if you 
could, please.
    Senator Nelson. Yes. In the aftermath of Hurricane Andrew, 
the reinsurance markets of the world went haywire. It was hard 
to get reinsurance and when you got it, you had to pay through 
the nose to get it.
    Over time, as the nurturing of the private marketplace came 
back, as the hurricanes did not hit that were devastating in 
their losses, that reinsurance market came back vigorously. And 
the insurance marketplace came back vigorously.
    The surplus in the property and casualty lines is somewhere 
in the range of about $300 to $350 billion these days. The 
overall insurance industry surplus is in the range of about 
$550 billion. And that is in an industry that has about $3 
trillion worth of assets.
    The insurance industry is strong. And that is why I say you 
have to have some ``skin in the game'' as you devise what is 
going to be the mechanism by which we offset these risks.
    Senator Bayh. Thank you.
    Chairman Sarbanes. Senator Allard.

                COMMENT OF SENATOR WANYE ALLARD

    Senator Allard. Mr. Chairman, I do not have any questions. 
Thank you.
    Chairman Sarbanes. Bill, thank you very much.
    Senator Nelson. Thank you, Mr. Chairman.
    Chairman Sarbanes. It is very helpful.
    Senator Nelson. Thank you.
    Chairman Sarbanes. Mr. Secretary, we would be happy to hear 
from you and your colleagues.
    Let me say to the Members of the Committee, given the 
nature of the subject, its complexity, and the admission on the 
part of all of us that we are searching for a solution and a 
consensus, I am not going to rigorously hold witnesses to a 
highly limited time. I think it is very important that they get 
the opportunity to lay out their position because this is not 
only a situation in which the concept is important, but the 
details of the concept are in important and interrelate to the 
judgment about what should be done.
    Mr. Secretary, that is not a carte blanche to go on 
forever----
    [Laughter.]
    ----but it is a partial carte blanche to go ahead and lay 
out your position.
    We very much appreciate your being here this morning. I 
might note that the Secretary was originally scheduled to come 
before this Committee. This had been arranged a long time back, 
to talk about the Treasury report on currency manipulation and 
international trade and that complex of issues.
    Given where we are, we thought we should change the nature 
of the hearing. So we are pleased that you are here. We would 
be happy to hear from you, sir.

                  STATEMENT OF PAUL H. O'NEILL

           SECRETARY, U.S. DEPARTMENT OF THE TREASURY

    Secretary O'Neill. Senator, thank you very much. And with 
regard to the other----
    Chairman Sarbanes. We will bring you back on the other 
issue.
    Secretary O'Neill. I was going to say, with regard to that, 
I know that we must deal with this issue today. But I look 
forward very much to coming back and sharing with you the 
action the Administration is taking and thank you all very much 
for what you are doing in strengthening our hand to deal with 
money laundering and associated issues that we believe will 
permit us to achieve the present objective of shutting down the 
financial means the terrorists have to support their 
activities.
    So I look forward very much to coming back for that 
engagement.
    Mr. Chairman, I do have what I would characterize as a long 
statement for me. But I have an oral statement that is quite a 
bit shorter that I think carries the essential points.
    Normally, as you know, I would submit my statement for the 
record. But this is a sufficiently complicated subject, that, 
if you do not mind, I am going to work my way through what I 
think will take maybe 10 minutes to lay down the terms.
    Chairman Sarbanes. Very good.
    Secretary O'Neill. It is a pleasure to be with you, Senator 
Gramm, Members of the Committee. I appreciate the opportunity 
to comment on terrorism risk insurance. We believe that there 
is a real and pressing need for Congress to act on this issue 
now. Market mechanisms to provide terrorism risk insurance 
coverage have broken down in the wake of September 11. Such 
coverage is now being dropped from property and casualty 
reinsurance contracts as they come up for renewal, with most 
policies renewing at year-end. If we in Congress fail to Act, 
reinsurers have signaled their intention to exclude such 
coverage, meaning that primary insurers may have to drop this 
coverage or institute dramatic price increases. As a result, 
after January 1 the vast majority of businesses in this country 
are at risk for either losing their terrorism risk insurance 
coverage or paying steep premiums for dramatically curtailed 
coverage. If businesses cannot obtain terrorism risk insurance, 
they may be unable to obtain financing or financing may be 
available only at a much higher cost. This would have 
widespread 
effects as businesses of all types may, for instance, be unable 
to expand their facilities or build new facilities.
    Let me state what I believe the problem to be. First, 
insurance companies do not take risk. They knowingly accept and 
mutualize risk. Because insurance companies do not know the 
upper bound of terrorism risk exposure, they will protect 
themselves by charg-
ing enormous premiums, dramatically curtailing coverage or, as 
we have already seen with terrorism risk exclusions, simply 
refuse to offer the coverage. Whatever avenue they choose, the 
result is the same--increased premiums and/or increased risk 
exposure for businesses that will be passed on to consumers in 
the form of higher product prices, transportation costs, energy 
costs, and reduced 
production.
    Another way, any of the choices has the potential to cause 
severe economic dislocations in the near-term, either through 
higher insurance costs or higher financing costs. Since 
September 11, the uncertainty surrounding terrorism risk has 
disrupted the ability of insurance companies to estimate price 
and insure risk.
    Now to the question of what I believe our objectives should 
be. In grappling with this problem, we have several objectives. 
First and foremost, we want to dampen the shock to the economy 
of dramatic cost increases for insurance or curtailed coverage. 
We also want to limit Federal intrusion into private economic 
activity as much as possible, while still achieving the first 
objective, and we want to rely on the existing State regulatory 
infrastructure as much as it is practicable to do so.
    I would like to talk briefly about a shared loss 
compensation program, which is what we are recommending that 
you consider. After reviewing an array of options, we have 
developed an approach that we believe best accomplishes these 
objectives. This approach reflects the current evolution of our 
thinking on this issue. But I also want to say that we want to 
work with you and with the Congress to achieve the best 
possible solution. This is such a new and novel problem, that 
we think we need to evolve in our thinking. I must say to you 
that the real test will not come in what we produce. We will 
only know if we have succeeded if life goes on in insuring a 
risk in the private market and businesses have the ability to 
achieve financing, so that our economy can return to a much 
higher rate of real growth than we are now experiencing. There 
is no other test that makes any difference. The real test is 
does what we do allow our economy to go forward in a good way?
    When terrorists target symbols of our Nation's political 
and military power, they are attacking the Nation as a whole, 
not the symbol. This argues for spreading the cost across all 
taxpayers. Yet, there are also reasons to limit the Federal 
role. If property owners do not face any liability from 
potential attacks, they may underinvest in security measures 
and backup facilities. In addition, the insurance industry has 
sufficient experience and capacity to price some portion of the 
risk associated with terrorism and has the infrastructure 
necessary to assess and process claims.
    Under the approach we are suggesting, individual's 
businesses and other entities would continue to obtain property 
and casualty insurance from insurance providers as they did 
before September 11. The terms of the terrorism risk coverage 
would be unchanged and would be the same as that for other 
risks.
    Any loss claims resulting from a future terrorist act would 
be submitted by a policyholder to the insurance company. The 
insurance company would process the claims and then submit an 
invoice to the Government for the payment of its share. In 
other words, we would use the existing insurance claims process 
infrastructure to deal with potential claims experience.
    The Treasury would establish a general process by which 
insurance companies would submit their claims. The Treasury 
would also institute a process for reviewing and auditing 
claims and for insuring that the private/public loss-sharing 
arrangement is apportioned among all insurance companies in a 
consistent manner. State insurance regulators would also play 
an important role in monitoring the claims process and insuring 
the overall integrity of the system.
    Through the end of 2002, the Government would absorb 80 
percent of the first $20 billion of insured losses resulting 
from terrorism, and 90 percent of insured losses above $20 
billion. Thus, the private sector would pay 20 percent of the 
first $20 billion in losses and 10 percent of losses above that 
amount.
    Let me say parenthetically here, when I say the private 
sector, I mean the customers of insurance companies, not the 
insurance companies, because if you understand how business 
works, then you know there are no insurance companies who can 
survive if they do not collect the loss values that they must 
pay out from the people that they service in the form of 
premiums. I think it is a very bad mistake of logic and 
understanding of how economics works to believe in fact that 
insurance companies actually pay for the losses that they 
cover. They are simply the transmission belt that mutualizes 
risk among people with similar exposures.
    Under this approach, the Federal Government is absorbing a 
portion, but only a portion, of the first dollar of losses, 
which we believe is important to do in the first year of the 
program. The key problem faced by insurance companies right now 
is pricing the terrorism risk. We favor a first-dollar loss-
sharing approach in the first year because we are concerned 
about premium increases over the next 12 months. We see this as 
the best way to mitigate against premium increases, but it may 
not be the only approach. And again, we want to work with you 
in finding an approach that will work in the marketplace.
    The role of the Federal Government would recede over time 
under our proposal, with the expectation that the private 
sector would further develop its capacity each year. In 2003, 
we would have the private sector be responsible for 100 percent 
of the first $10 billion of insured losses, 50 percent of the 
insured losses between $10 and $20 billion, and 10 percent of 
the insured losses above $20 billion. The Government would be 
responsible for the remainder.
    In 2004, the private sector would be responsible for 100 
percent of the first $20 billion of insured losses, 50 percent 
of the insured losses between $20 and $40 billion, and 10 
percent of the insured losses above $40 billion. The Government 
would be responsible for the remainder.
    To preserve flexibility in an extraordinary attack, 
combined public/private liability for losses under the program 
would be capped at $100 billion in any year and it would be 
left to the Congress to determine payments above $100 billion.
    The Federal Government's involvement would sunset after 3 
years. This approach would also provide certain legal 
procedures to manage and structure litigation arising out of 
mass tort terrorism incidents. This includes consolidation of 
claims into a single forum, a prohibition on punitive damages, 
and provisions to insure that defendants pay only for 
noneconomic damages for which they are responsible. It is 
important to insure that any liability arising from terrorist 
attacks results from culpable behavior rather than overzealous 
litigation. These procedures are important to mitigating losses 
arising from any future terrorist attack on our Nation and are 
an essential component of the program I have outlined.
    In conclusion, Mr. Chairman, for the reasons I have set 
forth, the Administration believes that the economy is facing a 
temporary but critical market problem in the provision of 
terrorism risk insurance. Leaving this problem unresolved 
threatens our economic stability. The approach I have outlined 
limits the Government's direct involvement and retains all of 
those elements of our private insurance system that continue to 
operate well and provides a transition period to allow the 
private sector to establish market mechanisms to deal with this 
insidious new risk that confronts our Nation.
    Mr. Chairman, I would be pleased to respond to questions 
that you and the Members may have.
    Chairman Sarbanes. Well, thank you very much, Mr. 
Secretary.
    Did you all examine the riot reinsurance program that was 
put in place after the 1968 riots?
    Secretary O'Neill. Yes, I think we looked at what we 
consider to be analogous kinds of situations and the staff 
looked at the riot reinsurance. I think we did not find it to 
be a very compelling equivalent to what we are facing with the 
terrorism risk that we are now facing.
    Chairman Sarbanes. Why not?
    Secretary O'Neill. Sheila, come up here, would you?
    You know Sheila Bair.
    Chairman Sarbanes. Certainly. Sheila's nomination was 
approved by this Committee in record time.
    [Laughter.]
    That is how well we know her.
    Secretary O'Neill. And I must say that I greatly 
appreciated it.
    [Laughter.]
    Ms. Bair. I must confess, that was one of the early 
suggestions that we got. We looked at it. I think we thought it 
involved too much of an infrastructure.
    As I understand that program, the funds are set up on a 
State-by-State basis. It looked like a more dramatic permanent 
fix to a problem that we thought was very temporary. It has 
been several weeks since we looked at it, but I would be happy 
to talk to your staff later about more of our analysis.
    Chairman Sarbanes. I think it is probably worth looking at.
    Mr. Secretary, how would you assure, if the Government is 
going to take a significant part of the cost of some of this 
risk, if the premiums charged by the companies for the balance 
of the risk will not be excessive, so that, in effect, the 
taxpayer is on the hook to pay the responsibility that the 
Government is assuming, and then the taxpayer as consumer is in 
effect overpaying on the premium side for the risk that is 
retained by the company?
    Secretary O'Neill. In a way, I think your question goes to 
the center of the problem.
    If you walk around the problem from the point of view of 
the different participants, let us say, first of all, that you 
are a business owner and you need to have terrorism risk 
insurance.
    Why do you have to have it? Because your bank will not 
continue to support you. They will not give you money, either 
for continuation for rollover loans or for a future investment, 
if you can prove to them that you have protected them and have 
the ability to pay back the money that they have loaned you in 
the event that you suffer the loss associated with a terrorist 
catastrophe. And so, as a business person, you are forced into 
a position where you must find some coverage.
    And under the proposal that we have made, if you saw this 
as an economy with one insurance company and one business 
person and you, the insurance company, now were at risk for $4 
billion. And let us say for purposes of illustration, that my 
business had a $4 billion catastrophic loss potential. Then, as 
an intelligent business person, you would probably seek to 
charge me something close to the value of me being the target 
of a terrorist event that costs me $4 billion.
    How do we keep that being the experience in the situation 
that we are talking about through the competitive process of 
insurance companies seeking to provide coverage, which is how 
they make their money, after all, by charging premiums with an 
expectation that, through the combination of premiums and 
investment, a flow of funds, that they are going to be able to 
make a market rate of return? That is what insurance companies 
do. Like all other business, they are out there trying to make 
a market rate of return. And through the competitive process, 
multiple millions of business owners will be approaching 
insurance companies and hundreds of insurance companies will be 
trying to make sales, if you will. And through that process, 
there will be a determination of what the premium is that is 
required on an insurable basis.
    And that is part of the reason that we have suggested that 
we take a 3 year approach to this. We are facing a cliff on the 
first of January. And since we have not really priced terrorist 
acts before, we are going to go through a learning process.
    I guess I would say, in a succinct way, the response to 
your answer is the competitive process will not permit 
rapacious pricing by the insurance companies because the 
competitive process will get this down to a level that the 
general judgment says, at this premium rate and with 
reinvestment of funds, we are protected against a $4 billion 
loss.
    Chairman Sarbanes. Well, I have other questions, but I will 
defer to my colleagues.
    Senator Gramm.
    Senator Gramm. Well, thank you, Mr. Chairman. Let me say, 
Mr. Secretary, that I have sat in many hearings on this 
Committee and others. I have never heard a better statement on 
the subject than you gave today and I want to thank you for it.
    Secretary O'Neill. Thank you.
    Senator Gramm. Let me go through three principles and see 
if you agree with them and then I want to just talk about your 
proposal and my own thinking on it. First of all, the question 
was raised earlier about eliminating risk, other than through 
law enforcement, private security, restructuring physically 
potential targets, and the use of American military.
    When we have used all of those vehicles, whatever risk 
remains, I would say as a first principle, is that risk cannot 
be eliminated. No bill that we could pass, no law that we could 
write could eliminate that risk, that all we can do is 
redistribute it, and ultimately, redistribute it from the 
person paying insurance premiums to the taxpayer. Do you agree 
with that principle?
    Secretary O'Neill. I think, generally, with this one 
caveat.
    If you think about insurance, what it does is it mutualizes 
the risk against people in like situations. If you think about 
the insurance industry taking this $4 billion worth of exposure 
in our first-year proposal, there is an assumption basically 
that there are enough people out there who are willing to pay 
premiums to have their terrorist coverage, that we have 
effectively mutualized the cost of the risk that is associated 
with their exposure to the people who choose to buy or who, for 
financial reasons, are forced to buy policies, and that 
population is a smaller subset than the general population. But 
at the end of the day, you either have that subset of the 
population that mutualizes and shares the cost and the risk, or 
the taxpayers do, yes.
    Senator Gramm. The second principle would be that private 
insurance as the basic structure is the cheapest way to lay off 
this risk and manage risk. And I do not know of any evidence 
that Government has ever been more efficient than private 
insurance.
    Secretary O'Neill. I would agree with you completely.
    Senator Gramm. The third is not a principle, but an 
objective. I am sure you share my objective that nothing we do 
here would in any way permanently get the Federal Government in 
the insurance business.
    Secretary O'Neill. That is the last thing we should do.
    Senator Gramm. As I look at your proposal, let me first say 
that I think your proposal is a good proposal. And I think if 
we adopted your proposal, that it would be a dramatic 
improvement over the status quo. Can anything be improved? I 
guess you can always debate that.
    It seems to me that, as I look at it, the various proposals 
that are being made--first of all, the proposal by the 
insurance industry, for us to sanction a monopoly reinsurance 
pool, is an absolute nonstarter with me. I assume it is with 
you.
    Secretary O'Neill. You are right.
    Senator Gramm. It seems to me that the real question is, 
based on our experience with reinsurance, could we, to use Bill 
Nelson's words, get the insurance--I do not want to use his 
words.
    [Laughter.]
    But the point is, it seems to me that if we are talking 
about a relatively small amount of risk given the size of the 
industry, $10 billion, for example, that if the Federal 
Government were backing up a program where the first $10 
billion was the liability of the 
insurance industry--in other words, moving your proposal really 
1 year forward--the disadvantage of that is you have a very 
compressed process whereby reinsurance would be marketed.
    My guess is that in this interim, you would have a lot of 
insurance companies that would become the primary insurer and 
they would line up partners individually, and then the 
reinsurance market would come in and say, well, we can really 
do that more efficiently if you will just simply contract with 
us. My guess is that that is how it would happen.
    That is the cost of skipping a year in your program. I 
think the advantage of skipping a year in your program is you 
would put pressure for the reinsurance market to develop. And 
one of my concerns is that the comforting effect of having the 
Federal Government there with the first dollar coverage, 80 
cents on the dollar, would be such that if I were in the 
insurance business, I might want to come to Congress in 9 
months and say, well, look, we have not developed this 
reinsurance market and therefore, we want you to extend this 
program. One of the advantages of skipping a year would be to 
force the development of this market sooner.
    I think also, from a political point of view, which is a 
relevant factor here, is that Members would feel more 
comfortable if the first exposure were private and the Federal 
Government were a backup, part of the backup process, rather 
than the Federal Government being on the hook for the first 
dollar. Let me just get your reaction to those alternatives and 
the trade-offs. It is not a question of right and wrong.
    Secretary O'Neill. No, I understand, Senator.
    I believe we have what you are saying as a suggestion for 
the second year of our program. Let me tell you why we did not 
end up with it as the first year of our program. We do not have 
much time, and I do not want to name them because I do not want 
television reporting that O'Neill said these are high-
visibility targets. But you all have in your own mind, there 
are places in our country that are high-visibility targets that 
have a billion dollars' worth of value. If I own one of those 
places--let me be the owner first--and I have to have insurance 
because my financing is going to walk away with me if I do not 
have terrorist insurance.
    So with the $10 billion, in effect, deductible that is out 
there for the industry to absorb, I am one insurance company. 
So if I am going to write insurance for one of these high-
visibility, multibillion dollar places, then I have to get a 
very big premium because the Government does not do anything 
until I have had a $10 billion loss. And it could be all my 
loss as an individual company unless there is a reinsurance 
pool possibility for a mutualization of the risk among 
insurance companies somehow. It is really that question of 
whether the market can develop quickly enough.
    I have no doubt that there will be a reinsurance market 
developed for this kind of risk-in-kind. But there is 
uncertainty and in the early days, my guess would be, because 
these are not fools who put their money into reinsurance or 
into insurance companies, they will insist in the early days on 
a higher risk premium than they will likely need going forward. 
There is a counterpoint, which is this, and it is directly 
related to what Senator Nelson said.
    What the insurance companies had to do after they had huge 
catastrophic losses because of hurricanes is they had to raise 
the premiums going forward to put themselves on a sound 
financial basis.
    Again, we are reminding ourselves, insurance companies do 
not accept risk. They mutualize it. And they pay their losses 
out of premiums and earnings on premiums that have come in. And 
it is that that provides the basis for our economy to operate 
in the way that it does to absorb risk.
    I do not have any trouble with your idea if we could 
quickly test it. And if I may offer this. One thing is we have 
talked about this. I do not think we are going to know whether 
the terms that you all adopt in your legislative proposal are 
going to work until we have had a real market test. And 
therefore, it may be useful for you all to think about the 
possibility of giving the Executive the ability to adjust these 
terms.
    If, in the first instance, after you have drawn a line and 
it does not work, and we find that we are in trouble because we 
do not have a whole lot of time to go through an elaborate 
reconsideration of the legislation.
    So just a thought for you. Believe me, not a reach for 
power. We could do without this. But we need a mechanism that 
is going to be able to adjust the market conditions and work in 
the real world, and we need it quickly.
    Senator Gramm. And my time is expired. But the problem is, 
the fact that you have that power affects behavior.
    Secretary O'Neill. You are right. You are absolutely right.
    Senator Gramm. That is the problem.
    Chairman Sarbanes. I say to my colleagues, we are going to 
hand everyone--because we do not have the lights here--after 5 
minutes, we will hand you a piece of paper. We do not want to 
cut anyone off in midstream. But then we would like you to 
start winding it up.
    Senator Schumer.
    Senator Schumer. Thank you, Mr. Chairman.
    I want to thank you, Mr. Secretary. You have been out front 
on this issue early, and that is really important, I think even 
in terms of assuring the markets now that we are looking at a 
solution. Just a quick question. There are some in the Congress 
who say we do not need any solution at all next year. Do you 
strongly disagree with that?
    Secretary O'Neill. I just do not think that we are in a 
workable position because with the reinsurance companies 
pulling out, we are going to face real-life situations out 
there where people will not be able to get financing.
    Senator Schumer. My two other questions relate to the 
specifics of your proposal. I am worried about two things and I 
wish you could address both.
    One is what Bill Nelson referred to as ``cherry-picking'' 
or ``fail-safe'' or whatever. Even if you do not do what 
Senator Gramm suggested, and do this very generous proposal in 
the first year, how do we know that some very important 
existing entities, buildings or just large physical entities, 
which is what is at the most risk, a lot of value, economic 
value concentrated in a small space, I guess, how do we know 
that they will get any insurance, that the insurance companies 
will say, look, I will write with this 80 percent, I will write 
for this, this, this, this, and this, but I will not write for 
5 percent of the economy. And that would really create unusual 
havoc.
    Secretary O'Neill. I think there is no doubt in my mind 
that the market will eventually provide risk insurance or 
terrorism risk insurance for everyone.
    But if we think about this problem in a way that we are all 
more familiar with. If you are buying automobile insurance, it 
is experience rated, which means if you are over 25 and you 
have three children and you do not drink and smoke and do other 
things, that insurance companies will like you and you will get 
the preferred premiums. If you are 15 years old and you have 
never been to driving school, your premiums are unbelievable.
    Senator Schumer. And there are some people who no one will 
insure.
    Secretary O'Neill. That is right.
    Senator Schumer. The State government steps in and does it.
    Secretary O'Neill. All right. And what the insurance 
companies do, though, effectively, and your example is the top-
off case, what they do is they create an experienced rate of 
premiums and assigned risk pools and that is going to happen in 
this case.
    It is obvious that some of the high symbolic value things 
have a higher risk associated with them than a suburban home in 
a tract development.
    Senator Schumer. Correct.
    Secretary O'Neill. And the insurance industry will work 
through its market process with bid and ask on the part of 
buyers and sellers, and the premium rates will be established.
    Senator Schumer. But how do we know--and I am going to ask 
my second question now so you can answer both. But how do we 
know that there are going to be some part of the economy, a 
valuable part, albeit, a small part, for which there will 
either be no insurance or the rate will be so high that, in 
effect, there will be no insurance? And if you could answer 
that. And then let me ask my second one.
    Chairman Sarbanes. You cannot do that.
    Senator Schumer. Yes, I understand.
    Chairman Sarbanes. We have been through that before. I can 
say, I have three questions.
    [Laughter.]
    Senator Schumer. I just want to hurry him up, so I get in 
my second before you start singing, Mr. Chairman.
    [Laughter.]
    Secretary O'Neill. I think we need to work this issue 
really hard. I think there are arguments that can be made on 
your side that we need to anticipate uninsurable companies or 
situations. We do not have a magic bullet answer that I am 
going to throw my body on the fire for. We should work with the 
Committee on this.
    Senator Schumer. I would like to work with you on that.
    My second question relates to my dialogue with Senator 
Nelson. I have heard from numerous banks, that they will not 
insure long-term projects if they are only given 1 year or 2 
years, or even 3 years, of some certainty that insurance will 
exist.
    We are talking about prospective rather than retroactive. 
We are talking about new projects rather than existing, 
although it might apply to refinancing as well. And that 
worries me.
    Now, the alternative proposal, the pool proposal, deals 
with that issue better, although, admittedly, it deals with 
some issues worse. Could you please address your view about how 
much dampening will be placed on the economy unless we have 
some longer-term solution, a 1 to 3 year solution. I fear it is 
moving back away from 3 years to 1, that if we do not have such 
a thing in place, we are going to prevent lots of lending and 
projects from being built. Even if the entrepreneur wants to go 
ahead, the banks are cautious fellows and they do not lend 
unless they are assured of insurance for the term of the 
project.
    Secretary O'Neill. Let me draw on my experience as an 
industrialist who had properties that were worth in excess of a 
billion dollars' apiece. And recall in that incarnation, what I 
found is that the insurance policies that I had that were full 
catastrophic coverage, including explosions, but not as a self-
initiated intentional act, but as a catastrophic failure of a 
boiler or something, that all of my policies had cancellation 
provisions in them and/or, and usually and/or, provision for 
resetting the premium on an experience basis.
    I think the idea that we have to provide 30 years' worth of 
iron-clad insurance protection to people is just wrong-headed. 
It seems like a plausible thing. But I have not found that to 
be my experience that my financial backers insisted I had to 
have 30 years' worth of iron-clad insurance coverage for a 
property that was at risk.
    It was at risk for cancellation and it was at risk for 
premium adjustment. But I never found a bank or that my equity 
investors said we cannot invest in you or we are going to 
discount your value because you do not have 30 years' worth of 
protection.
    Senator Schumer. But in this new world we are in, wouldn't 
the fact that we do not know what is going to happen create a 
real dampening effect on the economy if we have a short-term 
plan?
    Secretary O'Neill. I think if we can do something and set 
the terms down for a year, then we will have an experience base 
and say to the American people, which I think we can all do in 
good faith, if this does not work quite right, we are going to 
revisit it and we will adjust the terms and conditions because 
we are all determined that we are not going to be set back by 
these people and we will figure out a way to do it. I think we 
will be fine. As long as we make a good-faith commitment to the 
American financial community and the individual investors, we 
will be fine.
    Senator Schumer. Thank you, Mr. Secretary. Thank you, 
Chairman Sarbanes.
    Chairman Sarbanes. Senator Bunning.
    Senator Bunning. Mr. Secretary, I have real problems with 
the Federal Government guaranteeing profits for insurance and 
reinsurance companies.
    Secretary O'Neill. I would not ever suggest that we do that 
in any way, shape, or form.
    Senator Bunning. Well, your proposal does--I mean, you are 
guaranteeing whatever premium they charge, whatever risk and 
investment they make, they cannot lose over a certain amount.
    Secretary O'Neill. And I am assuming that the competitive 
marketplace will bring them into a position where they will be 
able to make a market rate of return on the risk that they are 
taking and no more.
    Senator Bunning. That is a debatable question in your 
proposal.
    Secretary O'Neill. I agree with what Senator Nelson said 
about insurance companies being flush and all the rest of that. 
I do not know about the rest of you, but I know a lot about 
investment. I do not know anybody who is rushing out because 
they think insurance companies are such a preferred investment 
vehicle, that they prefer insurance companies over all the 
other investments.
    My experience is that the markets grind very finely. And is 
anybody making a whole lot more than the market rate of return, 

either competition or the process of competition and price 
competition grinds people down so that it is very hard on a 
sustainable basis to make more than the market rate of return. 
I am assuming, with the event of terrorism, we did not lose our 
ability to run a capitalist society that produces that result.
    Senator Bunning. I am worried about the fact that if you 
have first-dollar coverage on a terrorism act, why should I as 
a reinsurer try to adjust to the market when the following 
year, you are going to take a certain percentage also? And only 
at the end of 3 years, I might want to change the way I 
approach my reinsurance company or my insurance company.
    Somebody brought the economy up and I think that is really 
interesting, that this act, this hideous act that happened on 
September 11, is a disaster for the economy.
    The economy was a disaster before September 11. This is 
just adding to it. We had an even growth in the second quarter, 
a negative growth in the third, and a negative growth in the 
fourth. And heaven help us, we had better not start out 2002 
with a negative growth in the first quarter then. Or else, 
these things will not mean a thing, what you are trying to 
accomplish by your proposal. We do have State insurance 
commissioners. They are capable of dealing with this problem.
    As Senator Nelson said, he had to deal with premiums and 
requiring premiums in law that required insurance companies to 
write catastrophic insurance for hurricanes. Or else they could 
not practice insurance or they could not do business in 
Florida. Well, there is the same capability in New York, 
Illinois, or wherever that we are capable of assuming there is 
major risk.
    I believe insurance companies intend to make money. And I 
believe reinsurance companies intend to make money, or they 
ought not be in business. What I am trying to say is, I like 
part of your solution, but I do not like the first dollar 
coverage of that. I think it is necessary we act quickly so 
that we insure and reinsure as quickly as possible so there is 
no more negative effect on the economy. But the Federal 
Government does things so poorly, and writing insurance 
policies would just be another one of those things that we do 
poorly.
    Secretary O'Neill. We do not want to write a single 
insurance policy.
    Senator Bunning. You want to have what we call an assigned 
risk pool----
    Secretary O'Neill. No.
    Senator Bunning. That is almost exactly what it is.
    Secretary O'Neill. No, no, no. We do not want to have an 
assigned risk pool at all. We do not want any pool. We do not 
want any Federal insurance policywriting or rating.
    Senator Bunning. What is 80 percent of $20 billion, then? 
That is your proposal for the first year.
    Secretary O'Neill. It is basically saying that is the part 
of a series of terrorist incident costs that we believe ought 
to be mutualized to the general taxpayer.
    Senator Bunning. In other words----
    Secretary O'Neill. In the first year.
    Senator Bunning. ----in the process of the insurance 
companies doing that, and the reinsurance companies doing that, 
you do not think that is possible?
    Secretary O'Neill. We think that there is a substantial 
risk if we do not do something like what we have recommended, 
we will have a significant dislocation in the economy on the 
first of January. And I can understand your view that maybe 
this is not right and maybe it is the wish----
    Senator Bunning. I like the other part.
    Secretary O'Neill. Maybe it is the wish of the Congress to 
take that risk. That certainly is a decision that you could 
make. And we would find out. This is different from lots of 
things we do here in Washington. This is going to either work 
or it is not going to work.
    Senator Bunning. I intend to work with the whole Committee 
to see to it that we come up with a reasonable solution. I hope 
you can work with us.
    Secretary O'Neill. Absolutely.
    Chairman Sarbanes. I am going to interject a question 
because it flows from what Senator Bunning has said. Did you 
consider the Government assuming the responsibility for all 
terrorist claims?
    Secretary O'Neill. Yes.
    Chairman Sarbanes. In effect, saying, it is the 
Government's responsibility to protect the society against 
terrorism. And if we fall short of that, the Government will 
pay these premiums. Therefore, to the insurance business, you 
do not have to factor it in. You do not have to take up the 
premiums. You do not have to have a record on which to 
establish it. And we will assume it.
    If there are no terrorist attacks, the Government does not 
pay anything. If there are terrorist attacks, the Government 
has to certify the claims and then pay them. Did you consider 
that?
    Secretary O'Neill. I think, Senator, it is fair to say 
that, within the economic team, and eventually, in a process of 
consultation with the President, we looked at every conceivable 
way of thinking about this problem, including 100 percent 
Federal role for costs directly associated with terrorism.
    On balance, we came down with what we have recommended to 
you, that we do this 3 year pilot process with the first year, 
80/20. And the reason we got to 80/20 is because we think there 
is a high probability that it will be possible for the private 
industry to write policies and be in the process for claims 
processing and working with companies, for companies to take 
investment actions and the management actions to reduce risks 
that otherwise might not be tended to.
    So, yes, we have worked this issue very hard, including 
everything that we thought was a logical possibility. And on 
balance, we have come down with what I have said to you today.
    Chairman Sarbanes. Senator Bayh.
    Senator Bayh. Thank you, Mr. Chairman.
    Thank you, Mr. Secretary. I was interested in your answer 
to Senator Schumer's question. I would like to ask you, given 
the state of the economy right now, the macroeconomic 
situation, it seems to me this is a particularly inopportune 
time to have a significant amount of additional risk put into 
the marketplace.
    We are trying to rebuild confidence on the part of 
consumers and on the part of people who make investments and 
all that thing. Now we are faced with a large, very difficult-
to-quantify risk.
    So it seems to me that something other than just a stop-gap 
measure was in order. We needed something to allow the industry 
to be able to quantify this risk and then we get out of any 
intervention and let them, assuming they have enough experience 
to do what they do better than the Government possibly can.
    But I took your response to Senator Schumer to be more of, 
not along those lines. You mentioned the cancellation 
provisions and the ability to increase premiums in light of 
experience and that thing. Given that, why would we do 
anything? So I am having trouble reconciling my own sense that 
this is a particularly inopportune time for this amount of 
additional risk, that we ought to do something, something more 
than just 6 months or 12 months. But I took your comments to be 
to the contrary. Maybe I did not understand you correctly.
    Secretary O'Neill. Well, what I said is I think we should 
put in place, by our thought process, we should put in place a 
3 year commitment from the Federal Government. But I am going 
to say to you again, the real test of what we do here is 
whether it works in the marketplace. And if someone has 100 
percent certainty about what is going to work in the 
marketplace, I have not yet found one. I believe we have to 
proceed with a sense of flexibility and caution and an 
expectation that we may have to make some adjustments.
    Senator Bayh. I guess that gets to the heart of my 
question, Mr. Secretary. At this moment, with the economy being 
in the shape that it is, perhaps it is better to err on the 
side of caution rather than additional risk-taking. Is that a 
fair way to characterize it?
    Secretary O'Neill. I am not sure how that translates into 
what conclusion you would draw.
    Senator Bayh. That is why you have a 3 year----
    Secretary O'Neill. On the side of caution, yes.
    Senator Bayh. ----proposal rather than a 6 month proposal.
    Secretary O'Neill. Six months, I would say, would not work. 
People need to be able to rely on at least a year's worth of 
understanding of what they are going to face and make a 
contract.
    Let me be a business person. And if you told me I have to 
face this music every 3 months with great uncertainty, I would 
say you are torturing me. Why are you doing this? It does not 
make any sense. I need to get this out of my life after I have 
made a decision for the next year and I will deal with it again 
maybe next year, which I have to do anyway under conventional 
and catastrophic provisions. You get revisited every year.
    And believe me, if you think risk adjustment is not real, I 
can tell you, if you have a boiler explosion, you know what the 
premium increase is going to be next year. It is going to be 
big enough so that, in an expected value time of 3 years or so, 
the insurance company got back the money it needed to pay off 
your claim.
    Senator Bayh. Anybody who has reported an accident with 
their automobile has gone through that, too.
    Secretary O'Neill. You know that.
    Senator Bayh. Just two other points. Something that Senator 
Gramm said and I think Senator Bunning touched upon it, too. 
The risk is what the risk is. We take steps to reduce it as 
much as possible. But at the end of the day, it has to be dealt 
with and distributed throughout society. But what we are 
dealing with here is a temporary market imperfection where the 
ability to quantify that risk is in doubt because we do not 
have enough experience.
    It seems to me that is what we are dealing with here. And 
we are trying to get us through this period until the market is 
able to perform the function it does much better than the 
Government possibly could. It is just a temporary market 
imperfection that we are attempting to address.
    My final question, Mr. Secretary, what about the British 
experience? They have had to deal with acts of terror for some 
time. How does your proposal differ from what they have 
instituted over there? And what has their experience been?
    Secretary O'Neill. Basically, we think the UK decided to 
put their national government into the insurance business. And 
we have elected not to take that route. I think it is true both 
for the UK and for Israel. They have both basically put the 
government into the insurance business.
    We just think it is a step way too far--in thinking about 
the logical possibilities, we did look at that possibility. But 
I think we would have to have some huge additional, horrendous, 
ongoing experiences to get to the point where we said, this is 
a sensible thing for us to do.
    Senator Bayh. Let us all hope it does not come to that. 
Thank you very much, Mr. Secretary.
    Chairman Sarbanes. Senator Allard.
    Senator Allard. Mr. Secretary, I agree with you on the 
limited role of Government. And I also agree with Senator Phil 
Gramm that we need to be very careful, again, about how 
involved Government is in this whole process. I am searching 
for ways to see just where that proper role might be. I would 
hope that, with time, we can completely phase the Government 
out of this. Terrorist acts are not anything new that happened 
with the attack on September 11. There were terrorist acts 
before.
    There is one question that comes to mind. Did you look at 
how the industry had factored in that risk, because some of 
those terrorist acts, even prior to that, showed the 
possibility--for example, in the bombing of the World Trade 
Center--of being huge in nature and catastrophic in nature. It 
seems like up to that point, the private sector had been 
willing to respond, or did you find that at that point in time, 
the private sector had not been willing to respond to that 
potential type of accident?
    Secretary O'Neill. You have the experts here from the 
insurance industry and I think your best qualified answer will 
come from them. Let me tell you my view of it, and this is from 
talking with high-level insurance executives around the 
country.
    I think there had been the terrorist act provisions and 
insurance policies and it was possible to have them as long as 
we did not have terrorist acts. And what we are seeing now is 
the realization that terrorist acts are not some unimaginable 
impossibility. They are a reality in our society, hopefully, 
not again and again. And therefore, the insurance companies are 
now having to think about the possibility of having to deliver 
on their promises to pay in the event of terrorist acts. And 
that means they have to address the real issue of pricing for 
these things, instead of it being a freebie that you would give 
some people comfort that they were covered for terrorist acts, 
when you had no intention of ever actually having to pay for a 
terrorist act.
    Senator Allard. Subtly, you implied, but there is a lot in 
the definition of a terrorist act.
    Secretary O'Neill. Yes.
    Senator Allard. In your comments. Are you thinking about 
leaving it up to each individual policyholder to define this, 
or is this going to be something that you are going to suggest? 
To me, that is a real bucket of worms.
    Secretary O'Neill. I agree with you. But I think we need as 
tight a definition as we can fashion of what a terrorist act 
is. If we are going to put the Federal Government on the line, 
then we need to know what it is that we are putting ourselves 
on the line for.
    Senator Allard. The other question I have is on foreign 
assets.
    In your proposal, I was not clear on how you would treat 
property owned by Americans. Are you putting them into that 
risk pool, or are you holding them out separately from that? 
And how do you do that?
    Secretary O'Neill. Well, what we fashioned is United 
States.
    But, again, as a business person who has operations in 36 
countries, now having seen this kind of issue up front and very 
clear, businesses are going to face this issue and different 
countries will sort the problem out in different ways. And 
equity-holders will pay attention to whether or not our risk 
has been covered.
    You know, I guess I can do this. There are lots of 
terrorist acts in some other countries that we are very good 
friends with and they have now incorporated these risks into 
their premiums in some of these other countries. It is not as 
though we are alone in the world. But businesses are going to 
have a much more complicated set of issues to deal with now. In 
fact, there is a different premium structure. If you are an 
American company and you have assets in places that are subject 
to lots of terrorist activity, you can tell the difference in 
your insurance cost.
    Senator Allard. I thought that was an important thing to 
think about, the foreign coverage, because, like the Chairman 
said, the question came to my mind, which government are you 
talking about, foreign investments?
    Secretary O'Neill. Right.
    Senator Allard. Some do a better job than others. And I 
would hope that we will improve and do a better job in this 
country as far as trying to keep terrorist acts to a minimum. I 
do not think it is a practical goal to completely eliminate all 
terrorist acts. I think we can take up organized terrorist acts 
perhaps that are international in nature.
    Secretary O'Neill. Again, Senator, as a business person, 
how you factor this in is important. Again, I do not want to 
name countries, but the financial premium of the intelligent 
business person requires in places that have more fragile 
governments and less robust protections against terrorist acts 
than the rest, then the discount rate that you can earn on your 
money is 18 or 24 percent instead of the 11 or 12 percent that 
is considered a reasonable rate of return in our economy before 
September 11.
    So there already is a risk adjustment mechanism in the 
capitalist system to take into account exactly what you are 
talking about. And it shows up in the premium that business 
people require in order to deploy capital in other societies.
    Senator Allard. Is my time up, Mr. Chairman?
    Chairman Sarbanes. Yes.
    Senator Allard. Okay. Thank you.
    Chairman Sarbanes. Senator Corzine.
    Senator Corzine. Thank you, Mr. Chairman. Secretary 
O'Neill, I appreciate the thoughtfulness of your presentation, 
even though I might not totally agree on all aspects.
    Let me just make a point that has been made and reinforced. 
This is a real economic issue for the moment and, in my view, 
the intermediate and long run. I might dispute a little bit 
about how much these risks get adjusted. People who write bond 
issues for 7 years, 10 years, and we have already seen a very 
significant erosion of yield spreads, virtual shutdown of the 
high-yield market.
    I saw where one of the great motor companies is paying 
almost 300 over Treasuries in intermediate and long-range, 
which is relatively unprecedented.
    I think some of this risk is already there and I think it 
will be an underminer of economic strength. So I think we need 
something, certainly in the short run, to address these issues. 
But I want to go to a statement you made, and you are talking 
about insurance companies.
    If we do not believe they can make money by underwriting a 
particular risk, they will not cover it. There will not be 
availability. And there is an assumption in this testimony and 
from a number of my colleagues that, somehow or another, we are 
going to be able to quantify terrorist risk next year. We are 
going to get enough experience that we will be able to 
understand that risk and therefore, people are going to want to 
accept that.
    And in its particulars comes the ``cherry-picking.'' But 
there is no reason to believe in my mind the reinsurers are 
going to say that this is a great deal and we ought to step 
into it. As a matter of fact, most business people do not put 
companies at risk on things that they do not know.
    We need a long-term solution that is not just completely 
dependent on the marketplace making a decision. I am actually 
troubled that there is not an understanding that our national 
defense somehow slips into what we are talking about here with 
regard to the insurance activity.
    There are examples and we do not need to debate the merits 
and the pool, but I have some sympathy for that. And we have 
actually practiced that in some ways, in ways that we would not 
otherwise have been able to have insurance and think about 
nuclear power plants as a perfect example. And while it is not 
perfect, it is better than if we did not have it.
    So I hope that we are not so firm in believing that we 
understand how this risk is going to work its way through the 
system. Are we going to be able to put a probability assessment 
on terrorist risk in 4 years any better than we are today, 
strikes me as a huge leap of intellectual view to be able to do 
that.
    At least one business person who would like to make money, 
I would not bet the ranch on something that I did not 
understand. That leads me to believe that there may be a reason 
to think more broadly about what the long-term solutions are. 
And since the President has talked about this as a long-term 
situation, this is not a 1 year or other type program.
    That said, I am sympathetic with what Senator Nelson said--
haste makes waste too often and there is a lot of reason to 
think that we ought to analyze this in great detail before we 
come to a long-term solution. And then I get to your 
suggestions, which are some good ideas, and I actually like 
Year Two or Year Three better because I do believe that the 
industry ought to be responsible for managing a substantial 
amount of this risk. It is the catastrophic risk that I am more 
concerned about.
    It just strikes me that this first dollar exposure is very 
high. I have heard your arguments about it. I would love to 
hear if there is any greater element on that. And then I have 
one other question.
    Do you have a feel for how much impact on the economy 
failure to act would have? Do you have estimates, macroeconomic 
views, about how much we would undermine the economy?
    So, really, two questions. Do you think we could expand and 
protect the economy by having a much larger first-dollar 
exposure of insurance companies?
    And have you all done a lot of market testing on that? And 
what do you think the impact of failing to do anything would 
have with regard to the economy?
    Secretary O'Neill. R. Glenn Hubbard, Chairman of the CEA, 
is here and I am going to let him answer the broader--and 
Glenn, you can correct me.
    [Laughter.]
    Senator Corzine. What would be the long-term impact?
    Secretary O'Neill. Absolutely. Again, Senator, if you think 
about this, and I like working problems in a way that I can 
understand them and think about them that reflects some 
experience.
    If I received a notice where I was before, that my 
terrorism risk coverage was cancelled next year, it would not 
have any immediate effect on a company of the size of Alcoa 
with $36 billion worth of market cap. But the S&P and Moody's 
would probably take a new look at my credit rating and because 
we were so terrific, they probably would not knock us down. But 
other companies that were not so terrific would probably get an 
adjustment in their rating and that would cause them in their 
next roll-over financing to pay more money and, in effect, the 
risk value would be imposed through the financial system 
indirectly instead of through a premium for insurance. And we 
do not really know what that is.
    To return to your question to the broader issue of what 
happens in the general economy, where you would expect to see 
the effect is in new project proposals. That kind of wash-
through effect that I have described would happen for things 
that are already there.
    Where you would see impact is in people not being able to 
get financing at all because they were not able to get 
terrorism insurance even during the construction period. How 
does that translate? I do not know. I will let Glenn give you a 
number for that.
    [Laughter.]
    Mr. Hubbard. I could do it now if you want.
    Secretary O'Neill. I am going to say one more thing first, 
Glenn.
    With regard to the proposal with the 80/20, I would argue 
that the companies, the reinsurance companies, will arbitrage 
between their aggregate exposure and the premiums that they are 
able to collect. And the more coverage that is written, the 
more the premiums will come down.
    The companies will make sure that whatever premiums they 
collect, their complete exposure is covered. Otherwise, they 
are not running a business. They are running a lottery. And 
that is why I would start with what you would say is first-
dollar coverage, I would say is still a considerable exposure 
for an individual company in the aggregate.
    I expect that this competitive process will arbitrage 
between the maximum exposure and they would collect all of the 
maxi-
mum exposure in premiums. It is a reason to start with a fairly 
small number and develop some experience instead of making the 
exposure big upfront because, at least I cannot imagine that 
the industry is going to collect less in premiums than what we 
say is their first-line exposure.
    Chairman Sarbanes. Well, the Secretary I know has to leave 
at 12:15 p.m. We still have some Members and, Chairman Hubbard, 
you will have a chance to go at some length.
    Senator Bennett.

             STATEMENT OF SENATOR ROBERT F. BENNETT

    Senator Bennett. Thank you, Mr. Chairman.
    Mr. Secretary, I appreciate you being here and I agree with 
Senator Gramm that your opening statement was unusually clear. 
We do not often get that. We appreciate the work that went into 
it.
    Let me just see if I understand what we are saying here, 
because this is not an area where I have a great deal of 
expertise or previous experience. I just paid the premiums and 
went on running the business.
    [Laughter.]
    There is an assumption that in the uncertainty of what we 
face, the initial premiums of the industry will be very high. 
Is that a correct assumption?
    Secretary O'Neill. First of all, there is an assumption 
that if there is no reinsurance pool, that individual insurance 
companies will have to collect premiums that are large enough 
to cover all of their potential exposure.
    Senator Bennett. I understand that. But even with the 
reinsurance pool, as the green eyeshade folks sit down and 
figure out what the risk is going to be, they are going to err 
on the high side.
    Secretary O'Neill. That is right.
    Senator Bennett. Simply because they have no experience.
    Secretary O'Neill. That is right.
    Senator Bennett. And presumably, by the end of 3 years, you 
will have had a track record of experience so that someone in 
reinsurance Company X, can say, we can come in under the market 
with this kind of a premium because we now have enough 
experience to know that the exposure is not going to be as high 
as we originally thought it would be and therefore, the 
competitive forces will bring the premiums down. Is that a fair 
assumption?
    Secretary O'Neill. I believe so, although I want to go back 
to the comment that Senator Corzine made about the difficulty 
of pricing the risk of terrorism. I personally, and I am sure 
you all join me, in not wanting to have enough actuarial 
experience that we can price terrorism.
    But if you know how insurance works, it is based on a set 
of actuarial judgments and experience base that gives one a 
basis for making some judgment about what the premiums should 
be when there is an event.
    And even for hurricanes and tornadoes, we have enough 
weather experience that it is now possible to do that. I hope 
we never have enough experience to figure out what the costs 
should be, and that should be our ultimate objective.
    But I think part of the reason we have suggested this 
graded approach is because we think we need some learning. We 
need to evolve our thinking. We have never really had to face 
this kind of issue, and we honestly do not know if it is 
possible to proceed in the way we have suggested and beyond to 
basically turn this over to a private function and let it 
forever be a private function.
    I am saying we can, if we do not have more terrorist 
experience. If we have lots of additional terrorist experience, 
I do not know what we do next.
    Senator Bennett. Well, you are going the same direction I 
am. At the end of the 3 year period, we need to revisit this 
and see exactly what we are because, put in a slightly 
different context, we are dependent upon the success of the 
Administration in conducting the war. And if the war goes 
badly, at the end of 3 years we are going to be faced with an 
entirely different problem than if the war goes well.
    Now you talk about the British. Their principal source of 
terrorism has been the IRA. And that has been going on for long 
enough that they do, unfortunately, as you say, have a base of 
experience on which to deal with it.
    We are in a world where we do not know whether the attack 
on the World Trade Center and the Pentagon was the ultimate 
gasp of this group and the absolute most they could possibly 
do, or if they have in the pipeline a whole series of attacks 
that could replicate that over the next 3 years.
    So I think you have had a thoughtful approach here, but as 
I try to get my arms around it, that is what I keep coming up 
against. I do not really know what I can endorse because I do 
not know what the risk is going to be, and presumably, nobody 
else does. Maybe Secretary Rumsfeld does, but he is not telling 
us.
    Senator Gramm. Because we would leak it to the media.
    [Laughter.]
    Senator Bennett. Not I.
    [Laughter.]
    Isn't that what is driving your decision as to the first-
year activity?
    Secretary O'Neill. Yes, it is, Senator. You said it very 
well.
    Senator Bennett. As I read the criticisms and listen to the 
criticisms, we say let's wait for the second and third year. 
Aren't you telling us we cannot wait because we have a January 
1 deadline with many of these policies and we do not know? And 
given the fact that the insurance company does not know, that 
means we hit January 1 with no insurance at all.
    Secretary O'Neill. Exactly right.
    Senator Bennett. Is that----
    Secretary O'Neill. Yes, sir. You said it extremely well.
    Senator Bennett. Well, I am not trying to say it extremely 
well. I am trying to get it in my own head so that I understand 
it when we come along.
    Thank you.
    Secretary O'Neill. Thank you.
    Chairman Sarbanes. Thank you, Senator Bennett.
    Senator Carper.
    Senator Carper. Thanks, Mr. Chairman. And to the Secretary 
we welcome you here. Thanks for joining us today.
    You brought your written testimony and it has been entered 
into the record. Everybody keeps saying how good your oral 
testimony was. Who wrote your oral testimony?
    Secretary O'Neill. You know, I am really delighted you 
asked me because it gives me an opportunity to say, I believe 
we have assembled the finest team of people that have ever been 
at one time at the Treasury. Sheila Bair, who you probably 
know, Peter Fisher, and David Ockhauser. I could go on naming 
fabulous people at the Treasury. I am proud to represent them 
and I am proud to say that Sheila wrote the oral testimony.
    Senator Carper. I know because while you were speaking, her 
lips were moving.
    [Laughter.]
    We are grateful for you and your team, for your 
presentation today.
    I want to go back to a question that I asked of Senator 
Nelson. The question dealt with the underlying financial 
strength of the industry itself.
    As I read the Administration's proposal, and I add up the 
industry's share of the potential cost, it looks like the 
industry's share in the first year could be as much as $12 
billion. In the second year, maybe $24 billion. And the third 
year, as I recall it, it was $36 billion. That is a lot of 
money. But compare that, if you will, to the reserves of the 
industry itself and whether or not those are fair and 
reasonable numbers.
    Secretary O'Neill. I think the reserves are irrelevant. The 
reason I think they are irrelevant is this. Again, if you are a 
business person and you understand how business works, then you 
know that the reserves that they have there are there for a 
good reason. And if they are excessive, then competition will 
grind them down over time.
    But the reserves are there because they are required to be 
there so that the company can operate in the jurisdictions 
where it sells policies in the event that there is a loss, the 
company can pay off the claims that it has contractually agreed 
to pay off. And so, the fact that companies have huge values in 
reserves has no relevance whatsoever to the taking on of new 
risk.
    Senator Carper. The second question I want to ask is this.
    There are others who are going to testify after you, some 
have liked what you suggested and some will not. You have heard 
from critics within the Administration, Executive Branch, 
Legislative Branch, and the industry itself, and others. What 
are some of the most valid criticisms that you have heard of 
the Administration proposals? How would you rebut those 
criticisms?
    Secretary O'Neill. Well, since we are near perfect, I do 
not know how to answer that question.
    [Laughter.]
    What do I think are valid criticisms? Senator Sarbanes 
asked me earlier, did we look at the possibility of simply 
waving a wand and saying, the American people are ultimately 
responsible for the cost of terrorist acts?
    I think that is a legitimate question. But there is a 
legitimate question beside it which says, or a legitimate 
thought process beside it which says, we have demonstrated that 
insurance companies are very good at assessing a risk and 
handling the claims process and working with clients to assure 
that clients take reasonable and necessary steps to reduce the 
risk that they have because they do not have proper security, 
say for this instance, or they do not have the structural 
integrity that is required to deal with terrorist risks, and 
the rest of that.
    Using the insurance companies as an intermediary to make 
sure that the Nation presses harder on building in reasonable 
protections against terrorist acts seems to me to be an 
intelligent argument and a reason to keep the insurance 
companies out there interfacing the rest of the world so that 
we do not have to create a huge Federal bureaucracy to run a 
parallel insurance system.
    But what this has the effect of doing by using the private 
industry sector to cover part of this risk is a way of 
spreading the cost to people who have assets at risk instead of 
to the general taxpayer.
    And there is an argument one can have about whether it is 
reasonable to spread the cost through our tax and 
redistribution system as compared to using an insurance vehicle 
to accomplish it. It is an age-old argument. We will never be 
done with it. But I think at the moment, one thing that is 
really clear to me, that we need to take some action and we 
need to do it very soon, or we are going to regret the 
implication that no action has for our economy.
    Senator Carper. Thank you very much.
    Secretary O'Neill. My pleasure.
    Chairman Sarbanes. Mr. Secretary, I just have a couple of 
thoughts I want to leave with you. I know you have to get away.
    First, presumably, whatever we do here becomes a precedent 
for health and life insurance issues as well. Is that a fair 
concern?
    Secretary O'Neill. We would like for it not to be. We would 
like to keep that off the table. But I can understand why you 
would think that. For sure, I think we should talk with the 
Committee about the reasons why we think it is not a good idea 
to include those. But we can do that.
    Second, the complexity of this issue is reflected in an 
article in today's Wall Street Journal. I do not know if you 
have seen it--``Insurers Have Easy Time Raising Money.''

    For a business faced with pay-outs of $40 billion or more 
in the wake of September 11 terrorist attacks, the property 
casualty insurance industry is having a remarkably easy time 
raising money from investors.

    Then it goes on and tells about what is at work in the 
market.

    Behind the enthusiasm for the sector is the fact that 
property and liability insurers, after a decade of competing 
for business by lowering prices and thus squeezing profit 
margins, now are in a position to increase the premiums they 
charge.

    And an analyst says, ``The pattern with catastrophic losses 
is that the price increases are greater than the losses.''
    And then they do a track in the market. They say, sudden 
premium. And they show that the index for U.S. property and 
casualty insurer stocks, which was trailing behind the S&P 
prior to September 11, has now jumped substantially above the 
S&P. I do not quite know what to make of that, except that I 
believe that it is pertinent to get that observation out on the 
table.
    The final point, when we did the Chrysler guarantee, which 
was done by this Committee, those of us who were Members of the 
Committee then, we wrote in provisions of fee charges and 
compensation to the Government for the guarantee for Chrysler, 
which, over time--actually, the Government came out more than 
whole in the situation.
    Now the airlines, we moved so quickly, we did not do that, 
although I think there is some discretionary authority in the 
panel of which you were a member and which is chaired by 
Chairman Greenspan who can place constraints of that sort on.
    Now in this instance, I gather that there is no 
compensation to the Government, is there, for taking on this 
risk that you are talking about in your plan?
    Secretary O'Neill. No.
    Chairman Sarbanes. I have no further questions.
    Senator Gramm. Mr. Chairman, let me just make the following 
comment.
    I think, first of all, I am not the least bit surprised 
that capital is available to go into insurance and reinsurance. 
This is obviously going to be a growth industry. We have had a 
cataclysmic event. And clearly, this is going to be a new 
market for a new product that, in essence, has not existed. 
People, at least, did not know they were covering it. And that, 
clearly, this market is going to come into existence.
    I see this, what you read there, I am not surprised and I 
view it as very good news because I think it is an indicator of 
two things.
    One, if I had to bet my life on whether or not the market 
would not solve this problem if we did nothing, I would not be 
willing to bet my life on it. My guess is they will solve it. 
My guess is if we did absolutely zero, that this thing would 
sort itself out. I think we are taking a risk that I am not 
willing to take by doing that. But I am not convinced that the 
market would not solve the problem.
    But what this says is that we can get the extra protection 
for the taxpayer by having a threshold or retention, as they 
call it in the insurance industry, of, say, $10 million. We can 
make that work.
    And I think this cursory data indicates we could. And I 
think, second, that this is something that at the end of 2 
years or 3 years, the market will be able to deal with.
    I think it is good news. I think it encourages us that if 
we just did nothing, that we might survive it. And if we do a 
bridge program, we probably will not have to do a permanent 
program. Also I think it says to me, do as little as we can do 
to hedge the risk for the economy, but do not do any more.
    What I am fearful of, and I would just tell you, I would 
rather have the Government come in and pay for every penny of 
terrorist losses for the next 2 years, than to get the Federal 
Government in the insurance business. That is the greatest fear 
I have, is that we are going to step into this thing now and 20 
years from now, we are going to still be in the insurance 
business. That just scares the hell out of me, much more than 
what is going to happen if we do not take the first step.
    Thank you, Mr. Chairman.
    Chairman Sarbanes. Thank you, Senator Gramm.
    I also note that The Wall Street Journal, which you 
probably saw----
    Secretary O'Neill. The cabbage article there.
    Chairman Sarbanes. They are eating cabbage now up at The 
Wall Street Journal.
    [Laughter.]
    It says, ``We loathe cabbage, so understand the sacrifice 
involved when we say that we would rather eat cabbage for the 
next 20 years than have to suggest that the insurance industry 
needs some government help.''
    And then they conclude, it needs some help, although they 
are not very clear on exactly what that ought to be.
    [Laughter.]
    They do end up with this paragraph, ``We will also admit to 
some nagging doubts about whether or not the industry is 
bluffing about shutting down on December 31. But we would 
rather eat cabbage than find out.''
    [Laughter.]
    Mr. Secretary, thank you very much. You have been very 
helpful. We look forward to working closely with your people as 
we continue to address this issue.
    Secretary O'Neill. Thank you.
    Chairman Sarbanes. Chairman Hubbard, if you can come on up 
to the table, we look forward to hearing from you.
    If I could have the attention of the next panel for a 
moment, presumably, Ms. Sebelius, Mr. McCool, Mr. Hunter, and 
Professor Froot are all in the audience.
    We are considering doing Mr. Hubbard and then going over 
until after lunch, say to 2:15 p.m. We will finish Mr. Hubbard 
here before we adjourn for lunch and then go over and come back 
to resume. But I need to know whether there are any of the four 
people scheduled to appear on the concluding panel who would 
not be able to accommodate that to their schedule.
    [Pause.]
    Well, not hearing anything to the contrary, I believe we 
will call on Mr. Hubbard and then the Committee will recess 
until 2:15 p.m. We will resume with the concluding panel.
    We want to give that panel ample time because it has been 
put together with--first of all, we very much appreciate the 
witnesses being willing to come on short notice, and we think 
it is a very balanced panel. We think it would give us the 
benefit of a lot of points of view, which the Committee is 
obviously trying to collect here this morning and tomorrow 
morning.
    Chairman Hubbard.

                 STATEMENT OF R. GLENN HUBBARD

             CHAIRMAN, COUNCIL OF ECONOMIC ADVISERS

    Mr. Hubbard. Thank you, Mr. Chairman. It was somewhat 
dangerous earlier when you suggested to a college professor 
little time limits. But I will not abuse that.
    In fact, I thought this morning's Wall Street Journal 
editorial that you quoted was a nice summary and actually, 
pretty supportive of what the Administration wants to do.
    What I would like to do----
    Chairman Sarbanes. Senator Gramm used to be a college 
professor and he has gotten very good at controlling his time.
    [Laughter.]
    Senator Gramm. Fifty minutes on Monday, Wednesday, and 
Friday, and it was a hour and 15 minutes on Tuesday and 
Thursday.
    [Laughter.]
    Mr. Hubbard. Exactly. And I promise to be even more 
abbreviated than that.
    What I wanted to do, since the Secretary ably walked 
through the Administration's proposal, was to spend some time 
with you on the economic case of why we think this is so 
important and for the areas where we find a lot of flexibility 
in hoping to work with you.
    I would like to begin by echoing what the Secretary said, 
that we are very grateful to the Committee for what it is done 
in the post-September 11 period and look forward to working 
with you on the terrorism risk insurance problem. The timing of 
these hearings is very significant, Mr. Chairman. Just to 
underscore what the Secretary said, it is not only important, 
but essential, that the Congress act on this issue before the 
end of the year.
    In the simplest economic terms, one could think of the 
shocks to the economy that we have seen since September 11 as a 
kind of supply shock to the economy's ability to supply goods 
and services. It is in our interest as a Nation to contain the 
increase in transaction costs broadly that these attacks have 
raised.
    A second feature that came up in discussion with Secretary 
O'Neill, is that the attacks also raised the uncertainty in the 
economic environment, uncertainty about the state of where the 
economy is, uncertainty about demand for particular goods and 
services like aviation to a myriad of other areas.
    Commercial insurance, of course, lies directly at the 
intersection of these two forces. Property and casualty 
insurance is one mechanism by which private economies respond 
efficiently to the risks that are presented in the environment. 
Risks are spread, so that for each business, a potentially 
large and perhaps even unknowable, cost, is turned into a 
stream of smaller known premium payments. The events of 
September 11 induced quite a large revision in perceived risks. 
In normal circumstances, increased risks are simply translated 
into higher premiums. That is a useful thing. There is an often 
too quick criticism from an economic perspective to criticize 
higher premiums. That is a useful economic function of pricing 
risk. It leads the private sector toward those activities where 
the risk is worth it, and away from foolhardy gambles.
    At the moment, however, we are not in normal times. The 
entire Nation is unsure about the likelihood of additional 
terrorist events. For insurance markets, unfortunately, the 
distinction between risk--that is, not knowing when an event 
will happen, but knowing a great deal about the odds of 
occurrence--and genuine uncertainty--where we do not know about 
the frequency of an insured event--is the key to being able to 
price efficiently. Experience with this new security 
environment will doubtlessly mitigate this difficulty over 
time. In the near-term, however, what we were concerned with in 
the Administration and what you have been concerned with in the 
Committee's efforts is the potential problem of a disruption in 
the property and casualty market in the short run.
    An interruption of coverage is a particular and extreme 
version of this problem. It would be a very large potential 
increase in transactions cost.
    We are all familiar by now with what happened in the 
commercial aviation sector--the disproportionate rises in 
insurance coverage or potential withdrawals of insurance 
coverage that hinder transitions to a new aviation operating 
environment. The phenomenon is more widespread. And here I want 
to walk through 
essentially the question Senator Corzine raised with the 
Secretary. Lenders typically require businesses of course to 
insure property before securing loans. So one immediate 
manifestation of the problem is to diminish bank lending for 
new construction projects. More important, perhaps, in the 
overall scheme of the economy is the impediment to transactions 
in existing commercial properties. That is, the resale of 
skyscrapers, pipelines, power plants, and other large assets. 
This changing hands, or recirculating assets, in the private 
economy is an important economic function. It goes to the heart 
of how we are able to reallocate capital in the economy.
    From an economic perspective, then, there are really three 
issues. One is this new projects issue. Second is the issue of 
capitalizing costs in existing projects. We know that the 
1990's were a period where, loosely speaking, we were willing 
to pay a lot for money in the future. Discount rates were low. 
The concern here is that abrogation or interruption in the 
insurance markets would raise discount rates capitalized into 
the value of existing assets, a serious problem, indeed.
    A specific numerical example is that about 3 percent of 
domestic income is MC&P premiums, about $155 billion a year. 
That was for Year 2000 where, arguably, very little terrorism 
risk had been priced. If one thinks, then, a substantial 
increase would have been priced in the short run, you can get a 
sense of a very large flow cost to inaction.
    And third, a well-functioning private insurance market has 
to be a core part of our financial infrastructure in the 
economy. And that is precisely why the Administration put 
together an approach and we look forward to working with the 
Committee and the Congress.
    I think there are very important principles for any Federal 
Government involvement here. And the first I think received 
perhaps not the full attention it deserved in the earlier 
discussion.
    I think the key and perhaps the most important element is 
that intervention should encourage and not discourage market 
incentives to expand the industry's capacity to absorb and 
diversify risk.
    A lot of the concern here has been expressed about problems 
in pricing. I will come back to that. That is an important 
problem. But perhaps the more compelling role for any 
government involvement at all would be in the issue of capacity 
in the short run. Toward that end, again, going to the article 
the Chairman noted in the paper, it is precisely high short-
term returns that induce investment in capacity and can be a 
positive thing.
    A second principle is that any intervention should be 
temporary, permitting us and you to review in the future the 
ability of the industry both to price risks and absorb losses.
    Third, private market actors should face appropriate 
incentives to encourage efforts to limit losses should such an 
event occur. And if I might digress for a moment, one of the 
problems with socializing all the costs that were discussed a 
little bit is that it simply provides no such incentive to the 
private sector, either to take responsible risks or for the 
insurance industry to process claims efficiently. I would 
submit that is a road down which you do not want to go.
    The fourth principle is that private sector uncertainty 
about liabilities that arise from litigation should be reduced, 
and I want to come back to that in a few moments.
    One thing that needs to be absolutely clear, and was 
missing even from the otherwise well-done Wall Street Journal 
editorial this morning, is that these principles do not imply 
providing government assistance to the property and casualty 
insurance industry. That is simply not the subject under 
discussion. The issue is mitigating short-run cost increases 
for an insurance scheme in an otherwise competitive market.
    We believe that the Administration's approach--and I am 
using the word approach rather than proposal simply because we 
do want to work with you on all the elements--match those four 
principles. I am not going to go over the approach again in 
detail. The Secretary already did that.
    But I will say again that the key element from an economic 
perspective is to mitigate short run, sudden increases in costs 
of insurance over the next year. The imposition of a 
deductible, Year Two in the scheme we are proposing, Year One 
perhaps in some of the proposals that the Committee is 
considering, and a subsequent increase in the deductible as we 
have proposed would permit the Federal Government to recede 
gradually from the market as the insurance industry adapts the 
measuring and pricing terrorism risk.
    I asserted a moment ago that the Administration's proposal 
as the Secretary outlined was consistent with the principles. 
Let me just walk you through a quick economic argument as to 
why.
    First, I think our approach is dead-centered on building 
private-sector capacity to absorb risk. It respects the 
insurance industry's proven ability to develop the capacity to 
price, to market, and to service products for new types of 
risks. I think it is important to keep some perspective here. 
In the past, there were naysayers who said that the private 
sector would not figure out natural catastrophe reinsurance. 
There are important differences in these occurrences, as I will 
come back to, but also some similarities. And I think 
experience has proven that the private sector has done very 
well. By providing a temporary bridge--3 years in our 
suggestion; we look forward to working with you on the length 
of that bridge--and steadily receding Federal presence and 
explicit sunset, we believe that the industry can grow, and it 
can grow well into this market.
    Second, and going back to a point that I made a few moments 
ago, the Administration's proposal is centered on the idea that 
a key limitation in the industry--the primary insurance 
industry and the reinsurance industry--is one of total capacity 
to absorb risk. 
It is for this reason that we think the economic function here 
is limiting maximum exposures in the event of very large catas-
trophes which would necessarily generate large transactional 
cost increases for businesses. And let us be clear, that means 
prices for consumers.
    A third reason we feel our proposal is consistent with the 
basic principles and economics outlined was that the industry 
is sharing in the losses, or skin in the game, in Senator 
Nelson's terms, up to a maximum loss, and the share that it 
shoulders rises over time. We can quibble whether it starts in 
Year One or Year Two, but I think I sense a pretty broad-
spirited agreement on that point. And there will be an 
important profit motive for insurance companies to begin now to 
refine pricing models. Again, I think that profit motive is 
both good and essential to making that private market work. 
There are economic benefits to the efficient pricing of risks 
and that needs to be left to the industry. Now, having said all 
of this, the potential losses that face insurers, whether they 
are from a natural disaster like Hurricane Andrew or from a 
man-made disaster like a terrorist act, depend not only on the 
security environment we have been talking about, but on the 
legal setting as well.
    And let me give you a quick numerical example and walk you 
through why we felt from the economics of the problem that some 
tort issues were important. The initial physical costs from 
Hurricane Andrew in 1992 of $6 billion became more than $20 
billion, and still ticking, in part because of the cost of 
litigation.
    The Administration wanted to include certain legal 
procedures that were designed to manage mass tort cases that 
might arise out of terrorism incidents. We believe very 
strongly that these procedures will bring damage claims closer 
to economic fundamentals and more importantly, from an economic 
perspective, reduce the uncertainty about the magnitude of 
potential claims. Much has been made in the discussion thus far 
this morning of uncertainty over costs of disasters, and that 
is an important problem. But go back to the Andrew costs. The 
morphing from 6 to 20 was not uncertainty about the hurricane. 
It happened only once. It was uncertainty about the legal 
system. We believe that consolidation of claims in a single 
Federal forum would help to ensure that the claims would be 
treated in a consistent manner, reducing uncertainty in the 
private sector and eliminating redundancy costs of litigating 
similar claims in multiple jurisdictions. We believe that 
limitations on punitive damages, obviously other than those 
that are directed literally against perpetrators and their 
betters, and proportional liability for noneconomic harm, 
reduces the potential for open-ended claims that would exhaust 
not only initial defendants' resources, but potential 
collateral defendants. This is the kind of uncertainty that we 
can work together to address, even while we are working 
together on the larger concern of terrorism.
    We believe these reforms are not just add-ons to an 
otherwise good proposal. They are absolutely essential to 
getting a private market and insurance up and running, and that 
appears to be not only our goal, but I think the goal of all in 
the discussion thus far.
    Let me say briefly a word about three roads not taken, at 
least in our approach that came up this morning. One was the 
issue of the monopoly pool model. Our concerns there were to--
to put them in economic terms. One was, while I characterized 
the insurance business as, roughly speaking, competitive, we 
believe these pools could generate the potential for 
significant monopoly power. Let 
us be clear where that goes. It is a higher cost of doing 
business, higher prices for consumers. We view that as 
unnecessary, while still preserving a legitimate role for 
intervention you might take.
    The second I referred to earlier--full government 
socialization. While it is possible to make an argument in that 
direction, I do not believe that argument holds much water upon 
closer inspection, precisely because of the failure to grant 
incentives both to individuals as managers of buildings and 
properties, and to the insurance industry as it processes 
claims.
    The third that came up was the issue of charging premiums. 
One of the things that I hope we all can agree, or I hope we 
can all agree, is that we do not want the Federal Government in 
the long-term insurance business. We believe that the short-run 
issue of cost-sharing that the Secretary outlined earlier is a 
way to get private-sector participation and some of the costs 
borne directly in the P&C insurance base, without charging 
explicit premiums.
    If we are all arguing among ourselves as to when we think 
the private sector will be able to efficiently price risk, let 
us ask the question when we think government officials would be 
able to do that. I think that would be close to a nonstarter.
    To conclude, I think it is our view that the economy as a 
whole is very resilient. And we believe that the combined 
efforts not only of what the Administration is doing, but, 
importantly, its work with the Congress, can provide 
transitional public policies to make sure that what might 
otherwise be temporary disruptions do not become permanent. 
Again, I think the property and casualty industry raises 
important issues. These issues are not issues about the 
industry. They are issues about consumers and the businesses 
that provide goods and services for them.
    Thank you, again, Mr. Chairman, for the opportunity and I 
look forward to yours, Senator Gramm's, or Members' questions.
    Chairman Sarbanes. Thank you very much. Is it your view 
that it is the cost of insurance that leads the insured to take 
steps against terrorism?
    Mr. Hubbard. Well, one appropriate--people, of course, have 
incentives for a variety of reasons to take measures against 
terrorism. The larger the financial incentive, the greater the 
incentive for hardening buildings, providing extra security 
systems, and so on, much as you might in your own home if you 
were faced with different pricing if you did different things.
    Chairman Sarbanes. It is your view that if the Government 
assumes the responsibility for paying the cost of terrorism, so 
that was then not factored into the insurance cost, that the 
insured would then be lax in guarding against terrorism. Is 
that your view?
    Mr. Hubbard. I think these are questions of degree.
    You are painting them as poles. I think the question is, 
what are the incentives for me to harden a building that I own 
or to make sure that, if there is an act of terrorism, that the 
damage is not any larger than----
    Chairman Sarbanes. I understand that. And you think you 
need to put a cost into the insurance in order to get you to do 
that. Is that right?
    Mr. Hubbard. That is correct. I think there are two reasons 
for that cost.
    One is for the private sector to face the right incentives. 
The other is for the industry to face the efficient incentives 
in processing claims.
    Chairman Sarbanes. Well, that is a different issue, the 
processing of claims. I recognize that point about using the 
expertise.
    Mr. Hubbard. Keep in mind----
    Chairman Sarbanes. In order to process the claims. But I am 
trying to get at apparently this view of yours that the really 
motivating factor to get building owners and managers to guard 
against terrorism is that it is factored into the cost of their 
property in casualty insurance. Is that your view?
    Mr. Hubbard. No. Keep in mind, Senator, that the difference 
between what is the premise of your question of what is in the 
Administration's proposal is 90/10 versus 100/0. So we are not 
talking about polar extremes.
    Chairman Sarbanes. That is right, which only underscores 
the thrust of the question.
    Let me ask you this question. Why are you putting the 
Administration in on first-dollar damages? If you say that the 
problem the industry has is limiting the maximum exposure, that 
is what creates the problem for them. So they do not know. They 
might have some huge bill to pay and therefore, they have to 
guard against that, some enormous amount of money.
    And I understand that argument. But why does the resolution 
of that argument require coming in for first-dollar damages on 
the part of the Government?
    Mr. Hubbard. The question is one of timing, Mr. Chairman It 
certainly is a long-run matter. If there were any role for 
government at all, it would be only on the back end, which is 
the premise of your question. But the problem we are facing is 
in the short run, in the market trying to figure out how to 
price things.
    Our view was, particularly in the current economic 
situation, 
we wanted to have as minimal a disruption, as minimal and 
necessary increase in property and casualty rates to move to 
that new environment.
    We have a deductible beginning in Year Two. You may well 
decide to do a deductible in Year One. But our philosophy was 
simply to keep the first year of this as blunting cost 
increases as possible.
    Chairman Sarbanes. And to ask the question that I asked 
earlier, how are you assured the companies do not use the 
premium boost in effect to overprice the risk to their pocket 
advantage?
    Mr. Hubbard. Well, I think the short answer to that is the 
single word, competition.
    The longer answer would be that, in the short run, it is 
quite likely that an industry like this could underprice as 
well as overprice if the problem is uncertainty. And the 
increased premium----
    Chairman Sarbanes. How likely do you think it is that they 
will underprice in this circumstance?
    Mr. Hubbard. One does not know until we put a specific 
policy on the table. But I have no doubt that the industry in 
the long run would not have significant competitive price 
discipline.
    In the short run, if the behavior you indicated happened, 
you would see a pretty rapid rebuilding of capacity in the 
industry precisely as the article that you referred to in The 
Journal suggests.
    Chairman Sarbanes. Well, the industry has very significant 
capacity now, does it not?
    Mr. Hubbard. Well, the P&C capital base is around $300 
billion. There are different lines and commitments of that. But 
that is a pretty significant capital base.
    Chairman Sarbanes. Yes. Senator Gramm.
    Senator Gramm. Mr. Chairman, let me say that I do not know 
that it is an extraordinarily relevant point, but I think the 
argument that you are making against just Government providing 
the coverage----
    Chairman Sarbanes. I am not making that point.
    Senator Gramm. I know.
    Chairman Sarbanes. I am just trying to explore the 
parameters here so we get some idea of where they are coming 
from.
    Senator Gramm. The point I made earlier, if I knew we were 
getting into the insurance business, I would take it as a 
preferable alternative for 3 years.
    The problem is getting out of it once you have gotten in 
it. Second, it gives you no bridge to get out of it. And you 
had added what I think is a very small factor in it, and that 
is, for example, as a business, and in some case, homeowners, 
you get lower insurance rates if you put in smoke and fire 
alarms.
    You might say, well, your children are sleeping in this 
house. Why didn't you do that anyway? Well, the problem is, you 
figured, well, it may not be essential, but if I am going to 
get an immediate reward, I do it. People do respond to this. 
You get lower life insurance for not smoking. Only an idiot 
would smoke cigarettes, given everything we know. I know many 
idiots.
    [Laughter.]
    And respect them on all other subjects.
    [Laughter.]
    On that subject, they act like idiots. But, anyway, so much 
for antismoking.
    [Laughter.]
    Let me say that I strongly agree with you, Glenn, and I 
just want to emphasize it, on this liability. The Federal 
Government is stepping in--however we do this, there is going 
to be Federal Government exposure. And I think the taxpayer is 
going to want to be sure that we are providing this assistance 
to keep the economy going. And since we are giving this 
coverage, the idea that someone could sue us for punitive 
damages or that we would be subject to class-action lawsuits, 
or that a substantial amount of the cost could end up being 
what at least a person like me calls frivolous lawsuits, is 
almost unthinkable.
    I think that is an important component here. And since we 
are backing up private money, if we do not give that coverage, 
at least in this interim program, to that money, it ends up 
being eaten up by those things and we end up being the payer 
sooner. So I think that is the important ingredient in your 
proposal, and I want to urge you to stand by it.
    Let me just conclude, Mr. Chairman, by saying that I think 
that the Administration's proposal has a lot of good 
ingredients in it. I think if you just throw away the first 
year of your program and start with the second year the first 
year, you will be making a major step in the right direction.
    Based on having listened to my colleagues today, we are not 
going on the hook for 80 cents out of the first dollar of loss. 
It may very well be a logical place for us to get together--and 
I think we can make it a bipartisan proposal, and if we can end 
up with something that the Administration supports, and we 
support it, it would be helpful.
    I think we do not want--whatever agendas we have that have 
nothing to do with this, I think we all agree that we want to 
leave it out of this. I think that is the way to do it.
    But I just want to thank you and the Administration for 
putting this, even though I do not support it, for putting 
together a very thoughtful and a very helpful proposal, and one 
that I think we can work on together, and I look forward to 
working with you on it.
    Mr. Hubbard. I think I will count you as a two-thirds 
supporter.
    [Laughter.]
    Senator Gramm. Well, two-thirds is not bad.
    [Laughter.]
    You win a lot of elections with two-thirds. I have never 
achieved that total.
    [Laughter.]
    Thank you very much.
    Chairman Sarbanes. Senator Corzine.
    Senator Corzine. Yes. Mr. Hubbard, I wonder if you have 
done any economic analysis if we do not act with regard to 
this. You talked about the categories of things that might be 
enacted in the economy. But have you done any runs of economic 
models to see how much it might actually cost the economy if we 
do not deal with this issue?
    Mr. Hubbard. Well, the quickest thing that we did that is 
to look again at the importance of premium domestic income and 
just make a range of assumptions about what might happen to 
premiums. The total amount of the premium paid is $155 billion 
in narrowest terms in the year 2000, a little over 3 percent of 
domestic income. So you can pick your favorite increase in that 
and get a sense of the cost hit to industry.
    I think perhaps the more serious concern is the 
capitalization factor if discount rates in projects get changed 
because of a belief in the lack of insurance. That changes the 
value of existing skyscrapers, power plants, and so on.
    Senator Corzine. I am not sure I fully understand the 
analysis, but that sounds like you are pushing upward of 1\1/
2\, 2 percent of GDP.
    Mr. Hubbard. I am not sure how you get to 1\1/2\. Just 
because the $155 billion----
    Senator Corzine. Knowing that is not going to be dollar for 
dollar translated through, and then you are going to have the 
secondary impacts with regard to the discounting numbers.
    Mr. Hubbard. Right.
    Senator Corzine. You are talking about a serious impact.
    Mr. Hubbard. That is a little too big. One hundred fifty-
five billion dollars is what was actually paid before when 
arguing there were pricing risks at zero.
    So the question is, how much do you think that would go up 
if you were pricing the terrorism risk? With 1\1/2\ percent of 
GDP, that is probably too extreme.
    But that calculation misses, I think, the capitalization 
effects and the value of assets, and that is probably what 
slows down development the most, the fear that lenders have 
that the projects would be worth less.
    Senator Corzine. Even by that analysis, it is a very 
substantial amount.
    Mr. Hubbard. Yes.
    Senator Corzine. How much of the $300 billion of the 
capital base of P&C's do you believe has been designated for 
terrorism risk?
    Mr. Hubbard. You mean that is available to pay?
    Senator Corzine. No, no. We have other lines, as you 
suggested. So there are all kinds of other calls on that 
surplus.
    Mr. Hubbard. My understanding from Sheila is that they have 
not reserved.
    Senator Corzine. I think that is the point, when we talk 
about how healthy the industry is with regard to surplus. And I 
am not particularly in favor of no first dollar participation, 
the first dollar position that we have here.
    I think that people take false security in thinking about 
$300 billion worth of surplus when we still have natural 
disasters and fires and other things that go on.
    I also would like to know if your intent with regard to the 
legal recommendations that you are making are designed only to 
fit to the bridge proposal you have here, or are they intended 
to be long-term recommendations with regard to terrorism risk 
insurance?
    Mr. Hubbard. Well, that, of course, would be up to the 
Committee and the Congress. Our view is that they go hand-in-
glove with a reform in this area. We are only considering----
    Senator Corzine. When they are proposed, do you expect that 
they would be proposed only limited to the proposal that you 
have and not deal with the overall context of terrorism 
insurance?
    Mr. Hubbard. If your question is beyond 3 years, if you 
decided to go the route of a more permanent program, I do not 
believe that the private market will function in the way we 
want and hope it will without these legal reforms.
    Chairman Sarbanes. So you are now reaching for permanent 
tort reform. Is that right?
    Mr. Hubbard. The question was if there were a permanent 
proposal. We are asking for a 3 year in our proposal set of 
packages. If you were designing a permanent system, it would be 
my advice to you as an economist that that system would not 
take off very well with private-market participation without 
these legal reforms.
    Chairman Sarbanes. You are complicating further a very 
complicated situation. I just want to make that observation. 
Tort reform is not a matter under the jurisdiction of this 
Committee, and it is a highly controversial issue. Now, in a 
sense, you are piggybacking it on here and we just have to take 
a look at that.
    Mr. Hubbard. If I might, Mr. Chairman, this is not a 
piggybacking. This is absolutely essential. If you go back to 
the argument that I gave you about Hurricane Andrew----
    Chairman Sarbanes. Well, some aspects of it may be and some 
may not be.
    Mr. Hubbard. No, that is right. What you need to do is take 
a look at what----
    Chairman Sarbanes. You are going to have one venue for 
hearing all these cases?
    Mr. Hubbard. Yes, Mr. Chairman.
    Chairman Sarbanes. Where would that venue be?
    Mr. Hubbard. It would be a single Federal jurisdiction.
    Chairman Sarbanes. Where?
    Ms. Bair. It would be the multidistrict panel on tort 
litigation.
    Chairman Sarbanes. Which is located, where?
    Ms. Bair. Federal Government court structure.
    Chairman Sarbanes. I know, but where is it physically 
located?
    Ms. Bair. Well, they would make the determination about 
where.
    Mr. Hubbard. How about Maryland?
    Ms. Bair. It would be in Federal Court. And this panel 
would make the determination depending on where the incident 
occurred.
    Chairman Sarbanes. You know, you all seem to assume that 
witnesses and aggrieved parties can travel all over the country 
in order to press their claims without experiencing great 
difficulties in doing that. I find that a fantastic assumption, 
if that is the premise of the system you are setting up.
    Ms. Bair. Senator, I think claims consolidation and 
punitive damages limits are very important.
    Chairman Sarbanes. No, no, you are adding other things in 
there. I am slicing this thing now.
    Ms. Bair. Right.
    Chairman Sarbanes. I am slicing it now to the venue. And as 
I understand it, you are going to have one venue nationwide. I 
am raising a very simple question, it seems to me; What does 
that do to litigants who would have to travel great distances 
at great expense and inconvenience in order to assert their 
legal claims? That is the question. What is the answer to that 
question?
    Mr. Hubbard. I am not an attorney. So the economic key to 
this is that you have a single jurisdiction. You can have 
different single jurisdictions, but there needs to be a single 
jurisdiction. The counter-argument to your claim is the venue 
shopping.
    Chairman Sarbanes. No, no. You suffer a terrorist problem 
and you live in Los Angeles, where it happened. And you have to 
go to Washington, DC or New York City in order to assert your 
claim. Do you see a problem connected with that?
    Mr. Hubbard. Well, again, you have a single jurisdiction 
per incident----
    Chairman Sarbanes. Do you think that has no problems 
connected with it?
    Mr. Hubbard. As opposed to the lack of consolidation of 
claims, then we are in an empirical argument, Mr. Chairman. The 
important thing is to reduce the transactions costs in the 
process so that the litigation costs do not wind up dwarfing 
the physical costs.
    Chairman Sarbanes. If you suffered the damage and you had 
to come all the way from Los Angeles to Washington in order to 
assert your claim, it would be an imposition on you, would it 
not?
    Ms. Bair. Senator, I just want to clarify. I do not think 
the Administration is talking about a single Federal district 
court to hear all terrorism claims. It would be per-incident, 
just the way consolidated claims in the Southern District of 
New York for the attacks in Manhattan.
    On a per-incident basis, we would envision going forward 
that those claims would be consolidated, presumably, in the 
Federal district court where the incident occurred. But I think 
that is the kind of thing that we are talking about.
    Chairman Sarbanes. Well, that is a more sensitive and 
rational response to what I have been getting.
    Do you have anything else, Senator Corzine?
    Senator Corzine. I am troubled by this context because if 
we think that this program is necessary to deal with a short-
run problem by the industry and its inability to price this 
risk and, somehow or another, we are going to get greater 
comfort 2 years and 3 years from now, which I am not certain 
that I accept that assumption, but let us just do that for 
conversational purposes, and we are going to change the tort 
structure for the period of time while it is on, and then it is 
going to come off, how is the insurance industry going to learn 
anything?
    Again, I am not arguing that we should do anything with 
regard to tort activities, but you are changing the whole 
rationale when you come back to go to the private market 
solution, pure private market solution, for the operation of 
this bridge.
    That does not make sense to me. You say we want this so 
that we will be able to have the price discovery mechanism have 
enough time to go through it, but we are not going to allow for 
any discovery with regard to litigation that might come from 
personal liability, culpability, or other issues.
    I do not think that the insurance companies are going to 
develop a book that allows them to be able to do that in that 
timeframe, unless you are arguing that we are basically for 
broad tort reform that goes beyond the timeframe of the bridge.
    Mr. Hubbard. I do not think that is any different from any 
other major element of the proposal. The theory is that you 
would review this in 3 years or whatever horizon you choose. 
That would include not only the legal process issues, but every 
other element.
    I accept that uncertainty, but precisely for the reason 
that the Chairman indicated, we did not want to use this as an 
occasion to look for an entirely different permanent piece of 
legislation. We wanted to focus this on the property and 
casualty problem.
    Chairman Sarbanes. Well, obviously we will have to continue 
to explore this. I think we have to simplify this so that we 
have a better feel for what the ramifications or consequences 
are, and so that it is more easily explainable in terms of the 
public understanding.
    But we will hear from the next panel, which I assume the 
Treasury will monitor. I certainly hope so, because I think the 
views expressed there will need to be taken into account. And 
we will hear from our two panels tomorrow and then see what we 
can sort out in terms of what is a reasonable and rational way 
to deal with the situation.
    I want to say to the Chairman of the Council of Economic 
Advisers because I am looking here at an article by John 
Sweeney in this morning's paper, which you have probably seen. 
The essential thrust of it is that there is an inadequate 
consideration of the question of emergency jobless benefits for 
workers and emergency health care coverage for workers.
    I think there is a growing danger that we are responding to 
this crisis and challenge in an unbalanced way. As someone 
said, actually, right at the witness table earlier today, the 
airline companies got help, but the airline workers did not get 
help. We are looking at trying to address a problem confronting 
the insurance industry, but there are other things that are not 
being done.
    They are less directly related than the airline situation 
where they did one side and not the other. But, nevertheless, I 
think the Administration needs to give some additional and 
careful thought to having a more balanced response to this 
challenge, so that there is a sense in the country that it is 
equitable in how it is seeking to deal with the situation.
    This is obviously bringing in a lot of issues that are not 
the focus of this hearing, and some that are well beyond the 
jurisdiction of this Committee. But I simply want to make that 
point to you, and I think the Administration needs to be 
thinking more broadly in those terms, in terms of having a 
balance in what they are putting forward and seeking that 
provides an assurance to the country that this is being done in 
a fair and equitable fashion. And I would leave you with that 
thought.
    Mr. Hubbard. Well, if I might just offer a quick thought in 
return, Mr. Chairman. The President proposed the displaced 
worker package that did indeed offer an expansion of 
unemployment insurance and increased the funding for national 
emergency grants, which would have provided a great deal of 
flexibility for Governors, not only in the jobless problem that 
we are now facing, but also in health insurance.
    Chairman Sarbanes. You are taking the CHIP money for health 
care for children and shifting it over, and a lot of us--it is 
not the purpose of this hearing to engage in that. But a lot of 
us think that that is just playing shell games.
    We have some CHIP money out there that has been provided to 
the States to get health care for children. That is the 
approach. Some of that money has not yet been spent by the 
States because we are still gearing up to it, and so forth. And 
you are proposing to take that money and move it over here to 
get health insurance to unemployed people. Now we want to get 
health insurance to unemployed people, but I do not think we 
want to do it at the expense of taking it away from children.
    Mr. Hubbard. I am afraid I could not just let that comment 
stand, Senator. That is not really the intent at all. The CHIP 
program, for reasons we do not have to go into here, has a lot 
of inflexibility in it and does not well cover populations it 
is designed to cover. And this would improve that flexibility 
greatly.
    Chairman Sarbanes. Mr. Hubbard, look. We could go at this 
all day long. Let me just say this to you. I think there is a 
percep-
tion in the country on the part of a substantial number of 
people, and a perception in the Congress on the part of a 
substantial number of people, that what is being done does not 
have a full equity component.
    I am just putting that to you in a sense, hopefully, of 
some friendly advice. Now you may choose not to act on it, and 
if so, I think this impression will continue to grow.
    But this Committee has certainly tried very hard in order 
to do that, if you witness the speed, and I think the care as 
well, in which we acted on the money-laundering issue. I am 
just passing this along to you. You may simply consider it as 
gratuitous advice and proceed to ignore it.
    Mr. Hubbard. No, I appreciate it very much, Senator. Again, 
we are very grateful for the work the Committee did on the 
money-laundering front.
    The one closing thought I would leave you with is, again, 
in your reference to the insurance industry, I would submit 
that is not why you wisely held this hearing. I think you 
wisely held this hearing about the cost of doing business in 
the country. And that is the problem that you are working 
toward and we hope to work with you.
    Chairman Sarbanes. We are trying to address this issue, 
otherwise, we would not have scheduled 2 days of hearings.
    Thank you very much.
    Mr. Hubbard. Thank you, Senator.
    Chairman Sarbanes. The Committee stands in recess until 
2:15 p.m., at which point we will take the panel that I 
indicated earlier that had been scheduled.
    [Whereupon, at 1:05 p.m., the Committee was recessed, to 
reconvene at 2:15 p.m., of the same day.]
    Chairman Sarbanes. The Committee will reconvene.
    I apologize to the witnesses. There are a lot of things 
happening all over the place here, as you can well appreciate.
    I see we have some time constraints here. Professor Froot, 
you have to leave, I gather, at 3:30 p.m.
    Mr. Froot. 3:30 p.m. or 3:45 p.m.
    Chairman Sarbanes. Why don't we go ahead and hear from you 
first, and then we will pick up with the others.
    And you, Ms. Sebelius, have to leave at 4:30 p.m. And we 
should be all right on that. Why don't we hear from you because 
then we will take the rest of the panel. And by that time, you 
may have to excuse yourself.
    So why don't you go ahead?

                   STATEMENT OF KENNETH FROOT

             ANDRE R. JAKURSKI PROFESSOR OF FINANCE

                       HARVARD UNIVERSITY

    Mr. Froot. Mr. Chairman, Senator Gramm, and Members of the 
Committee, I appreciate the opportunity to appear before you 
and discuss the insurance and reinsurance markets in the 
aftermath of the events of September 11.
    I come to this issue really as an academic economist, which 
I think of as a person who is good with numbers, but lacks the 
charisma of an actuary.
    [Laughter.]
    I am also very pleased to share with you this after-lunch 
session and note that it is an established fact that auto 
accidents peak between 1 p.m. and 3 p.m., after lunch each day.
    [Laughter.]
    What I would like to do is give you a little bit of a 
background on my own impression of the events surrounding 
Hurricane Andrew and Northridge and pull that forward to today.
    I think we run the risk of considerable dislocation in 
these markets going forward, given especially the annual nature 
of reinsurance renewals. However, at the same time, we need to 
preserve the benefits of a vibrant insurance marketplace, high 
quality, evaluation, pricing, allocation, and mitigation of 
risk.
    In the early 1990's, the United States experienced two very 
large natural disasters--Hurricane Andrew and the Northridge 
earthquake. The losses from these events were a shock to an 
industry that had rarely considered and had never seen losses 
of these magnitudes from natural perils. Firms were obviously 
stressed, along with their capital.
    Let me spend a second of my testimony here tracing out the 
industry response. First, as one might expect, insurance and 
reinsurance prices rose spectacularly immediately following 
Andrew, doubling between 1992 and 1993.
    The second point to make is that after these events, prices 
then fell steadily between 1994 and 1999, as the effect 
dissipated to about half of their level. Additional risk-
bearing capital and new firms entered the reinsurance industry, 
increasing competitiveness, and approximately $10 billion of 
additional capital flowed into new reinsurers, much of which 
was the result of the attractive post-event prices.
    I should comment that, in fact, as the stock prices we have 
seen in The Wall Street Journal today have increased, so, too, 
it has been regularly with natural catastrophes in the past, as 
the opportunities for insurers to write and as the demand 
increases following events. We see stock prices rise and 
capital then wanting to flow into that sector.
    The third point I take from this is that the growth that 
has occurred through the creation of a variety of new 
instruments and new institutional reinsurance mechanisms. For 
example, there have been new prototypes for reinsurers 
domiciled in tax- and regulation-favorable countries. These 
have been developed and highly streamlined over this time 
period.
    Fourth, additional sources of capital outside the 
reinsurance sector have become quite active. Cat bonds, and 
related financial 
instruments which could be purchased by investors became viable 
alternatives to reinsurance treaties as a way of transferring 
risk. Even though relatively few cat bonds have been issued, 
they have nevertheless promoted competition substantially in 
the industry.
    Fifth, while this is hard to summarize in numbers, the 
entire discourse surrounding natural catastrophe events changed 
during the post-event period. Insurers, reinsurers, 
commissioners, regulators, rating agencies, brokers, 
consultants, third-party risk assessment firms, all of them 
became much more aware of the possibility of these events, 
where they might occur, what kinds of buildings were at risk, 
how construction techniques can be approved, et cetera. The 
language and vocabulary surrounding these events grew 
enormously, and that led, of course, to better pricing in the 
reinsurance and insurance markets and a better awareness, not 
just for risk allocation, but also for risk mitigation.
    These changes have helped reduce the post-event price of 
reinsurance. But I think perhaps more importantly, they have 
also increased the amount of reinsurance protection that is 
commonly purchased today. If you look at the second graph of 
those color pictures, the ones down at the bottom labelled 4-D, 
it shows the fraction of reinsured losses covered at different 
levels of losses for the industry in 2000. The results are 
striking here. Before Andrew and Northridge, the most common 
layer of protection purchased against industry-wide events 
covered events of about $4 billion. As of 2000, the most 
popular level of loss protection had about tripled, to $12 
billion. In addition, today substantial coverage has been 
extended to much larger levels. Protection against natural 
catastrophe losses of $25 billion or more is not uncommon. This 
is the legacy of Andrew and Northridge, and it is a permanent 
one, given the changes discussed above. What do I take from 
this little bit of retrospective for policy pointers for today?
    First, I think it is very clear from this evidence that the 
reinsurance industry is efficient over the medium term. The 
industry can and does respond to large disasters. High prices 
certainly occur, but these motivate the response. Figure 4b 
shows prices have returned to their pre-Andrew levels, even as 
the lower Figure 4d shows that demand today for reinsurance has 
increased enormously. This is the sign of an economically 
efficient industry, one that can expand capacity, have 
financial innovation, and accommodate a large increase in 
demand with virtually no increase in price.
    Second, there is evidence that this medium-term response 
time has grown shorter today. Following Andrew, the post-event 
spike in prices took several years to undo. But there are a 
number of reasons to believe that the response would be much 
faster now.
    First of all, we built what I like to call hardware, 
institutions, Bermudan reinsurers, transformers, other 
financial institutional forms, including capital-market 
instruments, that can rapidly and smoothly incorporate new 
capital.
    Second, there is the software around that hardware. The 
expertise and knowledge of the brokers, the investment bankers, 
the reinsurers, insurers, rating agencies, investors, 
regulators, all of whom are much more familiar and fluent in 
the activities of risk transfer in these areas.
    I think there is plenty of direct evidence now that this 
hardware and software is at work. In just a month after these 
terrible events of September 11, one is aware of billions of 
dollars--to be precise, around $5 or $6 billion of committed 
funds already moving into the reinsurance sector.
    We have alluded already to The Wall Street Journal article 
in the paper today that cites another billion dollars from AIG, 
Goldman Sachs, and one other firm. And I am aware of at least 
another billion and a half of funds that are in the process of 
being raised.
    That would come to about $6 or $7 billion worth of funds, 
which is fully half of the entire industry requirement under 
the Administration proposal for the first year, all done, or 
not completely done, but all certainly moving very rapidly, and 
much of which is done in the first 6 weeks after these events, 
the first 6 weeks being of course the most shocking.
    Third, I would say that any form of sustained provision of 
reinsurance by the Government will impede the kind of progress 
we have made in developing the software and hardware and the 
ability to process these kinds of issues. The decisions that 
need to be made throughout the economy affect exposure in real 
ways. What types of steel and concrete reinforcements help 
reinforce buildings of various heights? What kinds of physical 
barriers around buildings shall we have? What kinds of 
equipment for checking, opening, or possibly sterilizing mail 
would we expect? I think it is not really a question, as we 
heard earlier this morning, of whether we will rebuild downtown 
New York. The question is how will we rebuild it? What kinds of 
coverage will be available for specific types of buildings? I 
think that is going to lead, in the end, to more rational 
mitigation of risk and better risk allocation.
    Fourth, the sheer level of uncertainty about the likelihood 
of terrorist attacks is not in itself a reason to replace 
market functions with Government programs. Critics of 
catastrophe modeling, of which there are many, including some 
of the most important reinsurance underwriters, argue that 
models provide false precision about the probabilities of 
disasters and that they are unknowable. The uncertainty 
surrounding the one-time potential impact of the Year 2000 
computer bug was certainly extreme. Yet, this did not stop the 
creation of private insurance dedicated to protecting against 
Y2K damages.
    And in that event, of course, with respect to Y2K, one 
might expect as an insurer that the firm's purchasing insurance 
might know a good deal more and have considerable more control 
over their exposure to that bug than the insurer would know 
about. That certainly is not the case with respect to terrorist 
events.
    In terms of the Administration's proposal, I support in a 
qualified way this approach of a limited, temporary, Federal 
intervention in the insurance market. A measured response is 
appropriate to assure continuity in the insurance markets and 
to support renewed economic growth. I agree with three of the 
basic principles of intervention that were discussed earlier, 
that intervention should generate appropriate price incentives, 
that it needs to encourage private market incentives to expand 
capacity as needed, and that it needs to help produce 
uncertainty about liabilities that are associated with 
litigation. In addition, I believe that if these three 
principles are to be satisfied, the sunset feature of the 
program is absolutely essential.
    In that spirit, I would also strengthen the second 
principle of this program that deals directly with the sunset 
feature. In my view, it should read that the intervention shall 
be absolutely temporary and primarily intended to resolve 
severe, short-term dislocations of the market due to a sudden 
shift in risk and coverage perceptions. I believe that is what 
we have and I believe that is a concern, indeed, for January 1, 
but I believe that these concerns die away considerably over 
time. I do concur with Senators Gramm and Nelson that a greater 
participation by the industry in the first-year losses is, at 
least for the first dollar claims, is probably appropriate.
    Over 1 or 2 years, however, I believe the market is fully 
capable of evaluating pricing and designing exposure to large 
risks. The existence of anything more than a targeted, highly 
temporary, Federal program is likely to forestall development 
of better insurance markets and pricing, better risk 
allocation, and mitigation decisions by the private sector.
    Thank you, again, Mr. Chairman.
    Chairman Sarbanes. Well, thank you very much. We appreciate 
your statement and the effort that went into preparing it. And 
we very much appreciate your being with us.
    Ms. Sebelius, we would be happy to hear from you.

                 STATEMENT OF KATHLEEN SEBELIUS

                PRESIDENT, NATIONAL ASSOCIATION

                   OF INSURANCE COMMISSIONERS

         COMMISSIONER OF INSURANCE, THE STATE OF KANSAS

    Ms. Sebelius. Thank you, Mr. Chairman.
    I am Kathleen Sebelius. I am the elected Insurance 
Commissioner from Kansas and serve this year as the President 
of the National Association of Insurance Commissioners. We 
appreciate the opportunity to be with the Committee Members 
today.
    Today, I really want to focus on three basic points. First, 
the NAIC and our members believe there is presently a need for 
the Federal Government, working with the State regulatory 
system, to provide appropriate financial backup to the private 
insurance market in order to ensure that the Nation's economy 
does not falter due to a lack of insurance coverage for 
terrorism. Although we have not endorsed any specific proposal 
for Federal assistance, we have adopted a set of 19 principles 
that are attached to my testimony that we believe should form 
the basis of a sound program of the Federal Government.
    Second, we believe Federal assistance should be a short-
term solution to stabilize the commercial marketplace, while it 
regains the risk assessment and pricing equilibrium needed for 
private insurers to underwrite terrorism exposures. Any Federal 
terrorism insurance program should be limited in scope and 
duration.
    And third, a Federal insurance program should maximize the 
use of market forces to add efficiency and reduce the risk of 
losses from terrorism and the potential cost to Federal 
taxpayers.
    Let me just start by saying that we really do believe that 
the insurance industry is well capitalized and financially able 
to withstand the pressures created by the September 11 
terrorist attacks, which right now are estimated to be upward 
of $30 billion. The industry is a $1 trillion business with 
assets of more than $3 trillion. And the preliminary loss 
estimates of $30 to $40 billion represents just 3 to 4 percent 
of the premiums written in the Year 2000.
    As regulators, my colleagues and I will continue monitoring 
the process to make sure that insurance promises are kept. To 
do our job, we have an array of human and technical resources, 
including our center office, the NAIC, of 51 State insurance 
departments that collectively employ more than 10,000 people 
and spend about $900 million annually on insurance supervision. 
In addition, the State insurance guarantee funds have the 
capacity to provide up to $10 billion to compensate American 
consumers in the event of insuring insolvencies.
    We would urge Congress to structure any Federal assistance 
program to take full advantage of the existing regulatory 
system. We have mechanisms in place to monitor solvency and to 
handle claims payment issues.
    The business of insurance is about measuring risks and 
selling promises to cover them with a reasonable profit. Over 
time, insurance experts have demonstrated a remarkable ability 
to adapt to unforeseen circumstances, while making available 
the insurance products that are essential to the growth and 
productivity of American business. As expected in a free 
competitive market, individual companies may stumble, falter, 
and even fail when substantial adversity strikes. However, the 
industry as a whole has a long and proud record of finding ways 
to overcome new obstacles, while advancing its business goals 
and serving the interests of the insurance-buying public.
    Thus, the NAIC believes Congress should begin its 
consideration of Federal assistance to the industry by 
recognizing the strength and adaptability of the private 
markets. Federal actions that disrupt or interfere with private 
market forces are likely to end up causing more harm than good 
for both consumers and taxpayers.
    State regulators know from their own experiences that 
Government action can help the market recover when it becomes 
overwhelmed by changing risk factors or catastrophic losses. We 
found successful Government assistance involves tailoring 
actions to fix specific problems and keeping the program as 
narrow as possible.
    State insurance regulators believe the current situation 
affecting the availability of insurance for active terrorism is 
similar in nature to other catastrophic events. Enacting a very 
temporary Federal solution will provide the necessary time to 
craft a more thoughtful, long-term solution.
    Here are three market factors that we would like to keep in 
mind. First, following the September 11 attack, Government and 
commercial facilities across America have begun to add security 
measures to prevent acts of terrorism and limit potential 
damages. As commercial risk managers review these new 
precautions, it is likely that they will become more inclined 
to offer terrorism insurance because the possibility and extent 
of potential losses will be reduced. At that point, we expect 
market forces will start filling the gap by making terrorism 
insurance available through the private industry.
    Second, the private market instills policyholder discipline 
to avoid insurance claims through the concept of coinsurance. 
Coinsurance means that policyholders are liable to pay part of 
any losses covered by insurance before expecting recovery from 
an insurer. It is a common concept known by everybody who buys 
car insurance or health insurance as a deductible, which you 
pay before receiving payment from the insurance company. And we 
think coinsurance should be considered by Congress as an 
important market discipline tool that works equally well with 
Government programs.
    Third, the scope and duration of any Federal assistance 
program will itself become a factor in the private market. Even 
though Congress is considering special Government assistance 
intended to operate as a supplement to normal business 
channels, the very fact that you will pay certain costs of a 
commercial business becomes a factor to be taken into account 
when the private market decisions are made.
    We think that it is appropriate in the short-term to have 
the Congress involved, but basically feel that it is 
appropriate to have that very short-term and very strategic and 
not disrupt the private market forces. We look forward to 
working with Congress, with insurers, with the Administration, 
so that the needs of individual Americans and our Nation's 
economy are met in a timely way.
    Thank you.
    Chairman Sarbanes. Thank you very much.
    Mr. Hunter, why do not we hear from you, and then we will 
conclude by hearing from the GAO.

                 STATEMENT OF J. ROBERT HUNTER

                     DIRECTOR OF INSURANCE

                 CONSUMER FEDERATION OF AMERICA

    Mr. Hunter. Thank you, Mr. Chairman. And thank you for 
holding this important hearing and I particularly thank you for 
doing the Nation's business in these hard days. We appreciate 
it.
    This hearing seems very familiar to me since, when I was 
young man and starting out as Chief Actuary of the Federal 
Insurance Administration back in the early 1970's, I was asked 
to calculate actuarially sound rates for the riot reinsurance 
program that Congress enacted to keep insurance available and 
affordable in the inner cities of America in the riot era of 
the late 1960's. There is a lot to fear in uncertainty then, as 
now. We were very concerned about whether there would be 
markets for insurance.
    Further, it is very familiar because the Banking Committee 
was where we held all the hearings where we developed the plan 
and implemented the plan. And Senator Proxmire, who was 
Chairman at the time, and others, were doing all of our 
oversight work. And so, here we go again together, Mr. 
Chairman, on another similar venture.
    I would like to start off by saying that CFA supports a 
Federal backup of the insurance business for the peril of 
terrorism. We think that there is need. In the testimony that I 
provided for the record, was a list of the principles that 
consumer groups will use to measure the acceptability of any 
plan for terrorism coverage from the perspective of the 
consumer.
    Chairman Sarbanes. Let me say that all of the statements 
will be included in the record in full. I know that people are 
now in the process of summarizing prepared statements. But the 
entire prepared statements will be included in the record.
    Mr. Hunter. Key among our principles that you will see that 
the taxpayers as well as insurers should be protected. By this 
we mean that actuarial rates should be charged for any Federal 
backup coverage. ``Cherry-picking'' by insurers should not be 
allowed. And the claims presented for Federal payment should be 
subject to Federal audit. The second principle is that State 
consumer protection should be maintained. The third principle 
is that consumers should be protected by making sure affordable 
and available insurance for terrorism is maintained. Fourth, 
insurance prices must reflect security-enhancing incentives so 
that free Government reinsurance would undermine that goal. 
Fifth, terrorism must be clearly defined and national in 
application.
    There are several serious flaws in both the industry 
approach and the Administration approach. Clearly, neither bill 
requires actuarial soundness. Indeed, insurers pay nothing for 
reinsurance in the first year of the industry program and never 
under the Treasury approach. Apparently, free Government 
reinsurance would even cover policies already in force for 
which insurers have been paid premium and are fully at risk 
today. This is a grossly improper use of taxpayer dollars. 
Neither approach is simple enough to be up and running on 
January 1, 2002, when the bulk of private reinsurance against 
the peril of terrorism expires.
    That is another serious problem. The insurer plan is worse 
than the Administration plan in that it provides an end of rate 
regulation and overrides any remnant of State or Federal 
antitrust law and sweeps in tort reform and is basically a 
Christmas tree.
    Unfortunately, the Administration plan shows that they do 
not really understand insurance, and if there are questions, I 
can explain at least two areas of what I mean. It is in my 
testimony that neither plan assures affordability or 
availability of coverage to reasonably secure risks. Congress 
should not rush to pass either of these severely flawed plans 
or a combination of such flawed plans.
    CFA proposes a plan that is simple and is constructed so 
that Congress can easily have it up and running on January 1, 
2002. In the written statement, I call it an interim plan, but 
since I put it forth at the NAIC yesterday and talked to a lot 
of experts, I think I am going to go bolder and say that maybe 
you could make it the plan. Here is the idea.
    The industry today has $300 billion of surplus which could 
be applied to any risk. Surplus is nondivisible. It is 
available for any risk. Considerably more than is needed for an 
efficient market. That is why premiums have been falling. It is 
overcapitalized the insurance industry. Even after September 
11, the vast majority of insurers could withstand easily 
another event of the magnitude of September 11. So we are sure 
that the plan need not cover first-dollar losses.
    CFA proposes that a retention for each insurer of 5 percent 
of its surplus as of December 31, 2001, the end of this year, 
when the program starts, be used as a retention for each 
company group. This protects weaker insurers from insolvency 
risk and minimizes interference with insurance pricing 
decisions.
    Terrorism must be defined clearly and a Federal official 
will determine the availability of the rest of the program, 
which is loans by the Government to insurers if losses exceed 
the 5 percent.
    If a terrorist attack occurs and an insurer suffers claims 
greater than 5 percent of its surplus, the insurer would be 
eligible for Federal low- or no-interest loans--that is up to 
you all--the term of which would be negotiated for up to 30 
years. This would spread the cost over time, an important goal.
    For each insurer, the discounted value of the loan would be 
limited to an additional 5 percent of that insurer's surplus. 
This is needed, this limit, in order to make sure that 
individual company balance sheets are not impacted by very 
large losses and the companies become technically insolvent.
    Amounts of money loaned in excess of the 10 percent of the 
surplus by a company would be repaid to the U.S. Treasury 
through a property casualty insurance industry-wide loan 
repayment mechanism. This loan repayment would be collected 
over a number of years sufficient to minimize the rate impact 
on consumers who would ultimately pay the cost of the coverage.
    Let me give you an example. If there was a $100 billion 
loss, next year, the first 5 percent would roughly produce $15 
billion that the industry would have to pay out of pocket. The 
next 5 percent, where the individual companies would come in, 
would produce another $15 billion. That would leave $70 billion 
for the spreading mechanism.
    Seventy billion dollars happens to be about 20 percent of 
the premium charged last year. If you capped it at 2\1/2\ 
percent, then the loan would have to be repaid over an 8 year 
period and that would be passed through to consumers.
    The loan would be repaid by the industry. It would be based 
on premium. And it would be piggy-backed. The States could 
collect it piggy-backed on the State premium tax mechanism, 
which is based on premium.
    This plan leaves the regulation of insurance fully in the 
State hands. The States should be required by the bill to 
assure availability and affordability of the terrorism risk, 
using their usual regulatory methods, including pooling by 
State, if necessary. Such pools are actually in place in about 
30 States.
    Further, the States should be asked to assure that the 
plans enhance security through discounts or other incentives. 
Congress should set goals for the States in this regulatory 
effort, but the States should do it. This requires little, if 
any, new bureaucracy at the State level since much of the work 
is already part of the State insurance department 
responsibility.
    And as to the Federal bureaucracy, the plan would require 
only a handful of people to monitor the request for loans, 
write up loan documents, advise the States on the amount of 
monies needed if the losses exceeded the 10 percent level, and 
monitor claims, which you must do under any, to make sure that 
they really meet the definition of terrorism.
    If there is no terrorist attack after January 1, 2002, the 
program never becomes operative. But you have given surety to 
the insurance companies that they know exactly what their 
maximum annual loss is.
    Congress should enact this plan, which protects the 
insurance industry, the consumer, and the taxpayer. It is 
certain, it has actuarially sound basis, it is simple, there is 
no hand-out, there is no bail-out, it works, and, more 
importantly, it can be fully operational on January 1, 2002.
    Chairman Sarbanes. Thank you very much. A very interesting 
statement.
    Mr. McCool.

                 STATEMENT OF THOMAS J. McCOOL

                 U.S. GENERAL ACCOUNTING OFFICE

    Mr. McCool. Mr. Chairman, Members of the Committee, we 
appreciate the opportunity to discuss the response of the 
insurance industry to the losses resulting from potential 
terrorist attacks and the extent to which the Government should 
play a role in addressing these risks.
    My testimony today presents features of selected insurance 
programs covering catastrophic or terrorist events, information 
on alternative mechanisms for funding insured losses, and 
outlines some broad principles or guidance that the Congress 
may wish to consider as it reviews possible ways to support the 
insurance industry in case of future catastrophic losses due to 
terrorist attacks.
    Regarding the first point, my full statement has fairly 
elaborate discussion of existing insurance programs. But in my 
short statement, I will just say that a number of the programs 
exist in the United States and other countries to help insure 
that insurance will be available to cover risks that the 
private sector has been unable or unwilling to cover by itself, 
including losses from catastrophic events and terrorism. 
Certain insurance programs are completely controlled and 
managed by the Government, while others have little or no 
explicit Government involvement. Likewise, in many programs, 
the public and private sector share risks and go in several 
different ways.
    With respect to the different mechanisms, funding 
mechanisms for funding insured losses, clearly one of the major 
issues that has been discussed in most of the testimonies today 
has to do with 
pricing. And again, I am restating something that was stated 
this morning, pricing for a program like this will be as 
difficult for 
the Government as it will be for the private sector, and maybe 
more so.
    In any case, you must try to balance concerns about 
underpricing and potential issues of insolvency for the private 
sector or oversubsidy for the Government sector if the 
Government sector is doing the pricing versus concerns about 
overpricing and the potential distortions in the market that 
could result.
    Part of the discussion that has come up in many of these 
programs is the extent that you engage in a pooling 
arrangement. Again, pooling arrangements can be pooled amongst 
private-sector parties or shared with the Government. And there 
is again a number of examples in some of the programs that 
exist currently throughout the world where the pooling 
arrangements are an important part of the program.
    Another issue that has to be determined by any program will 
be whether you try to prefund losses or try to do after-the-
fact assessment. And even within the option of after-the-fact 
assessments, one of the issues is whether you pay as claims 
come in or whether the Government provides when the initial 
claims come in and then the firms would pay these assessments 
over time through some type of a loan program.
    So there are a number of different ways in which such a 
program could be set up, again, with or without pools and with 
or without prefunding, and all of these are options for 
consideration.
    The Government could also fund any contingent liability in 
a variety of ways. It could charge a premium for the 
reinsurance protection it provides, accumulate a fund it could 
use to pay for losses. Alternatively, the Government could 
provide loans to the industry or fund its losses out of tax 
revenues, either with or without repayment requirements.
    In conclusion, a financially secure insurance industry is 
essential to the smooth functioning of the economy. There have 
been reports that without insurance coverage against potential 
catastrophic consequences of a terrorist act, investors and 
providers of finance may not be willing to provide capital or 
may impose very stringent terms. Any mechanism established by 
the Federal Government to support the ability of individuals 
and businesses to get insurance for terrorist attacks should 
address many significant concerns.
    First, the program should not displace the private market. 
It should create an environment in which the private market can 
displace the Government program. As a result, any program 
should be temporary. I think, again, these are principles that 
have been stated by others. And the third principle, which is 
one that GAO always supports, and again, it has been mentioned 
earlier, any program should be designed to ensure private 
market incentives for prudent and efficient behavior are not 
replaced by an attitude that says, do not worry about it. The 
Government is paying.
    So, Mr. Chairman, that is my prepared remarks and I would 
be happy to respond to any questions you or the Members of the 
Committee may have.
    Chairman Sarbanes. Well, thank you very much, sir. First, 
let me ask, I want to ask each member of the panel what they 
think would happen if nothing were done. And why do not we take 
you in the order in which you delivered your testimony.
    Mr. Froot. If nothing was done at all, I think there would 
be a substantial dislocation because of the calendar effects 
associated with the January 1 renewals. My guess is that that 
would be resolved within a year. But that, in the first year--
again, this is back to something we said earlier--I would not 
want to bet that we would not end up in a situation with 
extreme exposure in a few financial intermediaries or insurers, 
and perhaps some reinsurers, that was unable to be spread and 
therefore, in the event of a crisis, actually led to a severe 
collapse.
    Chairman Sarbanes. Do you think the people seeking 
insurance would be able to get it?
    Mr. Froot. I think in some circumstances, it would be very 
expensive. And, yes, I believe it would be hard to assure that 
insurance would be available in all cases.
    Chairman Sarbanes. So it would be expensive and it might 
not be obtainable? Is that what you are saying? Or it would be 
obtainable, but only at a very high cost?
    Mr. Froot. I do not think there is any guarantee that it 
would be unobtainable.
    Chairman Sarbanes. Ms. Sebelius.
    Ms. Sebelius. Senator, In the short term, we have a real 
crisis in the commercial marketplace because I do not think 
that money is going to be available for the development or 
financing of large commercial properties without insurance.
    We are already as regulators getting notices from companies 
who would like immediately to institute restrictions on 
terrorism coverage. Those are being filed across the country as 
we speak.
    And if this were a different timing, I think if we were 
having this hearing in February or March, and we had gone 
through the renewal period, it is conceivable that the private 
market could figure out a solution by the renewals the 
following January. What we are faced with here is a calendar 
problem because the renewals are imminent. And I really think 
it is highly likely that it would be very difficult, if not 
impossible, to get any kind of coverage at any price for this 
risk in the short run without some program.
    Chairman Sarbanes. Both for existing buildings and for new 
development?
    Ms. Sebelius. I am not the capital market expert. But we 
have been told that the real problem is not initially with the 
insurance itself. It is really without the guarantee that you 
could insure an attack in the future in the short run. Nobody 
is going to put substantial amounts of money down for ongoing 
financing or for new developments. So it would dry up the 
capital market. And I think that could happen very quickly.
    Chairman Sarbanes. Mr. Hunter.
    Mr. Hunter. It does hinge on what type of policy you are 
talking about. A company like State Farm, which is insuring 
homes and cars, many of them all over the country, a big spread 
of risk, probably would not have much of a problem dealing with 
not having terrorism reinsurance. It does not buy much 
reinsurance anyway because it effectively reinsures itself with 
the spread, and so on.
    But when you get into the commercial accounts, that is 
where you would have the crunch, big accounts that this morning 
Senator Nelson called target risks, would have trouble getting 
insurance.
    There would be applications made to the State insurance 
departments to allow the exclusion of terrorism. Now some 
States might disapprove those filings and therefore, then 
companies would have to make a decision whether to cancel the 
whole policy or not cancel, but nonrenew the whole policy. But 
that is a potential that--how do you put a number on it? I 
believe it is severe enough that Congress should worry about 
it.
    Chairman Sarbanes. Mr. McCool.
    Mr. McCool. Well, again, I think that the problem would 
exist, clearly. The question of how large it would be and how 
it would show up, there is a number of different ways it could 
show up.
    Clearly, you could have cases of--there would be no doubt 
that there would be much higher premiums applied to commercial 
insurance in particular, and possibly there is going to be 
nonavailability of insurance.
    I guess the next question would be, if someone did not have 
insurance, either it was not available to them or the price was 
so high that they would think about opting out, what would be 
the impact on someone providing financing to them?
    And again, there would be ways for the financiers to adjust 
by asking for more upfront equity, by lower loan-to-value 
ratio, by asking for higher returns. But there would be a lot 
of different ways in which this could show up. And it would 
clearly have a potential significant impact.
    Chairman Sarbanes. I want to repeat the question I asked 
and get two of you to answer. Is there a divide or difference 
between getting the insurance for existing buildings and 
getting the insurance for new development, new buildings?
    Mr. Hunter. Again, it depends on the building. If you are 
talking about big target-type buildings, I think they would 
have trouble keeping the insurance they had and the new 
buildings would be even more problematic because they do not 
have the history of 
insurance.
    Now, obviously, these big accounts also have some ability 
to self-insure and so on. So they may have some ways to get 
through that and find some kind of reinsurance at very high 
levels. But until the reinsurance market is assured, I think 
you would have trouble with those big accounts.
    Mr. McCool. Again, I would agree that new construction 
would probably be more affected. But I do not think that you 
could ignore the effects on existing structures.
    Chairman Sarbanes. I see my time is up and I yield to 
Senator Miller.
    Senator Miller. Just a couple of things, Mr. Hunter, help 
us to understand this better. What kind of distortions would 
there be in the insurance market if we created the 
Administration proposal? In other words, what happens to a 
market when you give away a Federal guarantee that does not 
cost the industry anything?
    Mr. Hunter. Well, it means that the rates can be much lower 
obviously than they might otherwise because the insurance 
companies do not have to find actuarially priced reinsurance 
protection. They know they have free reinsurance for 80 percent 
from dollar one, and a $12 billion maximum loss in a year.
    That is a lot of assurance and it means the pricing of 
things like security would be less enhanced. There would be 
less reason for people to toughen their buildings and put 
security guards out there and spend that kind of money, 
whereas, if insurance was fully priced, there would be that 
additional incentive, besides saving lives and the other good 
things that happen. The financial incentive to do those, that 
would be weakened.
    Senator Miller. Thank you. Let me ask this question of 
everyone on the panel, except Mr. Hunter.
    [Laughter.]
    What do you think of Mr. Hunter's proposal?
    [Laughter.]
    Mr. Froot. Let's see. I like it to the extent that 
allegations that parts of the insurance industry are over-
capitalized are true.
    That is, that, in certain sectors, mutuals in particular, 
it may be very difficult to reduce the amount of capital, even 
as risks decline. And so, therefore, putting that capital to 
work, in a sense, directly through this kind of program would 
make a lot of sense.
    For companies that are not overcapitalized, it would be a 
mistake because, in the end, after the event, they would be 
burdened going forward with a substantial liability, additional 
liability, which would place them in a financially inflexible 
and relatively fragile position compared to where, judiciously, 
they would believe they should be.
    Ms. Sebelius. Senator, I am not sure I can make a terribly 
well qualified review of Mr. Hunter's program. I have heard the 
basic outlines now twice. But there is a bit of misconception. 
Regulators want companies to build reserves. You want companies 
to build reserves as a policy program because without those 
reserves, they may end up not being able to pay the claim.
    So I do think that we want to be careful about assuming 
that if they have assets in reserve, that somehow, that is 
extra money. That is there to back up the policies that are in 
force in the marketplace.
    I think the concepts are interesting about the notion that 
there would be some repayment scheme at some level and probably 
is one that should be looked at by the Congress.
    Some of these issues really are kind of insurance-related 
principles. Some of them are really public policy decisions. 
And I am not sure that, as an insurance regulator, I am very 
well qualified to suggest what your public policy decisions may 
be. And I believe a lot of what Mr. Hunter has outlined really 
falls into more the public policy area.
    Is it a good idea that taxpayers should expect this money 
to be repaid? How much should the industry count on? We 
certainly support the notion that dollar one involvement from 
the Federal Government may not be the best way to approach 
this, a deductible system, setting a level that gets some 
insurance capital involved before there would be any kind of 
Government involvement may be a more appropriate approach, and 
that is part of what Mr. Hunter has talked about. So I do not 
know if that is helpful, but I do not know a lot about the 
plan.
    Chairman Sarbanes. Could I just ask a simple question? It 
is possible that if the reserves are built up too much, that 
they have been charging too much on the premium side, is not 
it?
    Ms. Sebelius. That is something that regulators look at on 
a fairly regular basis when companies apply to us, that 
certainly more of that regulatory oversight is exercised in the 
personal lines market less than in the commercial market 
because we assume in a competitive market that the 
sophisticated buyer will essentially use the marketplace to 
drive rates down. And markets are pretty competitive at that 
level and they have the ability to do that.
    Chairman Sarbanes. Thank you. Senator Miller.
    Senator Miller. Let me ask Ms. Sebelius a question while 
she has the microphone. The industry's concern about the 
Administration's proposal is that they will not be able to 
price risk. Do you agree with this concern about their ability 
to price risk?
    Ms. Sebelius. We have had this discussion, all the 
regulators in the country, frankly, who have been in town for 
the last couple of days, to look at the aftermath of September 
11 events on the industry. We have talked a lot about the 
industry's really amazing ability to price anything. I mean, 
not that anyone would have foreseen September 11, but they have 
had lots of unforeseen issues in the past and have relatively 
quickly, as the Professor suggested, figured out a pricing 
mechanism. It may tend to be very conservative initially, over-
reserving, charging too high, and then the market drives that 
down.
    I think the issue here is how quickly can that happen? And 
our concern is that the timetable of the January 1 policy 
renewals are such that we do not have a lot of faith that can 
happen in that kind of timespan. But I am very optimistic that 
within the course of the next year, they can begin to 
appropriately price this risk, they will price it, and they 
will sell it.
    Senator Miller. Thank you. My time has run out.
    Chairman Sarbanes. No, go ahead, Senator.
    Senator Miller. Mr. McCool, do you have a statement on Mr. 
Hunter's proposal?
    Mr. McCool. Well, again, we do not endorse or die.
    [Laughter.]
    I think it has some interesting features. It does have 
first-dollar coverage, which again we think is something that 
is a good idea. It has a formula for allocating the first-
dollar coverage on a firm-by-firm basis, which again is an 
attractive feature. Whether capital is the right basis or some 
other basis could be used, the fact that it does have an 
allocation formula on a firm-by-firm basis I think is a useful 
feature. Again, the fact that it repays the Government over 
time is something that the GAO would never be against.
    [Laughter.]
    And again, at what rate is up to you to decide.
    Senator Miller. That is an attractive feature. Thank you.
    Thank you, Mr. Chairman.
    Chairman Sarbanes. Senator Schumer.
    Senator Schumer. Thank you. I appreciate the panel being 
here. I have looked at the testimony and I am sorry I could not 
be here the whole time.
    Let me ask each of you, and particularly those who seem to 
like the Administration's proposal, how do we prevent ``cherry-
picking?'' How do we prevent 5 percent of the most vulnerable, 
or at least as perceived, the most vulnerable properties from 
just being excluded and not getting insurance?
    Professor Froot.
    Mr. Froot. I would have said that ``cherry-picking'' is a 
great problem when it comes to someone trying to buy for you 
life insurance or for themselves more extensive medical 
coverage, or any of those things. I think those are examples 
where, in those markets, the individuals have some control over 
the risk and they have some knowledge about the risk that the 
insurer would not have. That is where we tend to see ``cherry-
picking'' most severely.
    I do not think that is the case here. I do not think there 
is much risk that a particular building owner knows more about 
the risks of terrorist attack than can be easily established by 
someone looking to write a policy for that building.
    Senator Schumer. I do not follow you. I do not understand. 
The Empire State Building, Disney World, the Hoover Dam might 
be places that might be much riskier.
    Mr. Froot. Much riskier.
    Senator Schumer. To insure after September 11. And if we 
just say that the Government will pick up 80 percent of the 
costs of whatever insurance you write, some might say, well, 20 
percent is still too much to be dangling out there for these 
type risky things. We are not going to insure them any more.
    Mr. Froot. But I tend to agree with Ms. Sebelius, that, 
basically, that there will be competition, there will be a 
desire to write that policy, and there will not be a concern 
that one is being adversely selected in writing that.
    That is to say, that because you come to me and are willing 
to pay a very high premium, that means an even higher risk than 
I would have ever guessed.
    Senator Schumer. Again, we are talking past each other. I 
am not worried about competition between the two. I am saying, 
if 
everybody comes to the conclusion that $10 a square foot to 
rent the Empire State Building in insurance, the owners will 
not be able to make any money and the building will go under, 
the building will not be insured. That is what I worry about. I 
worry about a significant portion of properties not being 
insured.
    Ms. Sebelius.
    Ms. Sebelius. One of the features that you may want to look 
at, as a possibility in partnership in this Government 
involvement, would be to disallow exclusions for terrorism 
coverage, which forces the risk to be spread, essentially, and 
tie that or tie any opportunity to participate in the Federal 
program to not having the exclusions. The issue we are dealing 
with right now State-by-State is really holding those to see 
what is going to happen.
    Senator Schumer. That is a pool of a sort, but a pool you 
could live with.
    Ms. Sebelius. But one of the issues may be spreading that 
risk so that every company is in the game from the outset and 
then you have a realistic possibility. If you let people begin 
to exclude out of the pool the price against the pool to, as 
you say, cherry-pick the properties, I think then you really 
have the potential of a very distorted marketplace very 
quickly.
    Chairman Sarbanes. Could I ask on that very point? You say 
in your statement, and I am now quoting, ``Many people in 
Congress apparently think that States require private 
businesses to carry insurance against terrorism, and that 
failure of the private insurance market to offer terrorism 
coverage will result in violating State laws and regulations. 
We believe there is a misunderstanding of what State laws 
require and what State insurance regulators do.'' And then you 
say you did an electronic search of State laws and regulations 
with references to terrorism and you found nothing.
    Now, maybe I have a misunderstanding. It was not my premise 
that the current law and regulations require terrorism coverage 
because, in a sense, it is not been at the forefront of our 
concerns.
    But I thought that you could require that the State 
insurance regulators have the authority to require that the 
policies cover terrorism. Is that correct?
    Ms. Sebelius. I do not think that is accurate, Mr. 
Chairman, without legislative intervention. For instance, 
legislators in some States have said health care policies must 
have the following features in it.
    At the State office level--some of us have and all of us do 
not even have this authority, is actually to deny exclusions. 
We do it in reverse. When exclusions are filed with our office, 
there are statutes right now in some States that have deemer 
provisions. Unless you take some action and that could be 
administratively overruled, they go into effect. So it is 
really the reverse.
    The issues that come as exclusions are looked at by our 
office, but there is really not an affirmative requirement that 
policies must have a variety of features in them unless that is 
something that the legislature has actually taken on as a 
legislative initiative.
    Chairman Sarbanes. But if you did not give the exclusion, 
wouldn't terrorism be covered?
    Ms. Sebelius. At this point, that is the likelihood, that 
as a State insurance commissioner--most of us either could deny 
the exclusion or take some emergency rule to not allow the 
exclusion to exist. Now having said that, they do not have to 
offer the policy at all. I mean, that is step two. You could 
deny the exclusion, but that does not mean the company has to 
write the policy.
    Chairman Sarbanes. Well, I understand that.
    Senator Schumer.
    Senator Schumer. Just one other question. I think earlier, 
Senator Gramm said that he might consider supporting 100 
percent insurance for 2 years, Federal, 100 percent coverage 
Federally--did he say this? Yes? I am surprised--to avoid the 
Federal Government being involved permanently.
    Now, of course, if we had a series of terrorist incidents 
even at the end of Year 2, or after Year 3, we would have to 
come back, is my guess, of great magnitude. So I do not quite 
get it because that really depends on what happens post-
September 11. But would any of you want to comment on that 
idea?
    Mr. Hunter. That is a terrible idea. Part of the reason it 
is bad to have no premium is it would undermine all the various 
normal market workings and incentives for more secure risks. 
You really want to have safer places out there.
    Senator Schumer. Hunter says Gramm ignores free market.
    [Laughter.]
    Ms. Sebelius. Senator, I also think that we, at least, 
believe you really want the private market forces to get back 
in the game as quickly as possible and to begin to figure this 
out.
    A 2 year hiatus with no risk, no capital, no anything, may 
really be exactly the wrong message to send. I believe very 
limited, very strategic backup help, but urging the private-
market forces, essentially, to regroup quickly, recapitalize 
quickly, and sell the policies.
    Senator Schumer. Could I ask each of you one final 
question?
    First, in writing, if any of you have ideas on how you deal 
with this ``cherry-picking'' issue beyond what we have 
discussed today because, to me, it is a very vexing issue, 
could you send them?
    Would that be okay, Mr. Chairman?
    Chairman Sarbanes. Sure. Certainly.
    Senator Schumer. For a week. It is not mandatory, but if 
you have some good idea, I would love to hear it and I bet the 
Committee would as well.
    My final question is, as you may have heard, if you were 
here earlier, I am very worried that people will not endeavor 
to begin large new projects if they are worried even if they 
know that in the first year there will be insurance, if they 
worry that there will not be in subsequent years. Is that a 
valid worry? And should that play a role in what we pass here, 
if we were to pass something?
    Do any of the witnesses----
    Mr. Hunter. It is a valid worry. But you could set up a 
program that said, if you enter into a multiyear project, 
requiring multiyear insurance, you have to notify the 
Government, and perhaps you could even have a multiyear policy, 
even if the program ended. You still might be able to do 
something.
    Senator Schumer. The policy could be backed up in Year One.
    Mr. Hunter. Either a policy or a loan guarantee, or however 
you do it, you could have a multiyear basis for that.
    Senator Schumer. Right. Any other comments? Ms. Sebelius.
    Ms. Sebelius. I did hear or was able to watch some of the 
hearing this morning and heard that concern voiced. I guess we 
are fairly confident and, again, it is based on looking at what 
happened after Northridge and Hurricane Andrew, what happened 
in various situations, that the multiyear funding issue is 
probably less a problem, assuming that we do not have a series 
of attacks, less of a problem than this strategic issue right 
now. I am fairly confident the market would rebound and be 
issuing policies in the future.
    Chairman Sarbanes. I take it it's your view that if this 
had happened next February, that the private sector might have 
been able to work it out by the end of the year, given the 9 or 
10 month period within which to do it. Is that right?
    Ms. Sebelius. Well, there has been some discussion that 
certainly the problem is really exacerbated by the timing, 
given the proximity to the January 1 expiration of virtually 
all--not all, but a large portion of the reinsurance treaties. 
We are in a particularly difficult time. I think what you would 
have had in a different timetable is at least several months to 
see how much capital came back in, what the market solutions 
were. We just do not have that luxury at this point.
    Chairman Sarbanes. Of course, one could then, carrying the 
logic of that out, say, well, we have a situation where we have 
to get over this hurdle or this hump that is facing us, and 
enough time to see how it works. If it does not work out, it 
could be revisited, I guess, would be the argument.
    Ms. Sebelius. Well, that is certainly why we would support 
a firm sunset, a very short timetable, and the opportunity 
certainly is there to revisit or renew. But we think having a 
time certain where the program ceases of fairly short duration 
makes very good sense and it keeps pressure on everybody to 
figure out the solution.
    Chairman Sarbanes. Now, Mr. Hunter, let me try to take your 
proposal and see if I--and Mr. Froot, I know you have a time 
problem. So any time you have to go, just excuse yourself. We 
understand your situation and we very much appreciate that you 
came.
    Not that these are minor differences, but is it accurate to 
say that you differ from the Administration in that you would 
require the industry, in effect, bear the burden upfront up to 
a certain amount? As I understand your testimony, your figure 
was I think $35 billion. Is that right?
    Mr. Hunter. That is what I said in my testimony. In the 
plan that I just outlined, it would probably be more like $30.
    But, yes.
    Chairman Sarbanes. And then beyond that, the Government 
would come in to cover the loss, but it would do it on a loan 
rather than a grant basis. Is that right?
    Mr. Hunter. That is correct.
    Chairman Sarbanes. And then the industry would repay the 
loan over whatever terms you have worked out over an extended 
period of time.
    Mr. Hunter. Yes.
    Chairman Sarbanes. They would have to keep the premiums up 
in order to do that.
    Mr. Hunter. Yes. You could put a cap on how much that could 
be per year, like 2, 3, or 4 percent per year, so that the 
premiums would be maintained at a relatively low level for the 
loan repayment period.
    For a typical homeowner's policy, you are talking maybe 
between $16 and $24 a year additional. Obviously, for a big 
target risk, it might be several thousand dollars a year.
    Chairman Sarbanes. What is your reaction, Ms. Sebelius, to 
that scheme--plan, I guess.
    [Laughter.]
    Ms. Sebelius. I guess, Senator, I do not know quite what my 
reaction is. I do think that it shifts a lot of the burden for 
terrorism coverage in the short-run particularly on to those 
Americans who are buying insurance policies and away from, if 
you accept the notion that, somehow, this is a public policy 
issue and the Government has some legitimate role, then I think 
having the taxpayers at large bear some of this burden as 
opposed to just the insuring consumers bearing it through the 
higher premiums they are paying, I think a lot of Mr. Hunter's 
concept really assumes that consumers who are buying insurance 
products over a longer period of time would be paying off the 
loans as opposed to the taxpayers at large paying them. That 
may be too narrow a focus for that to bear all that risk.
    The insured public are also taxpayers. But, essentially, 
they would be picking up more of a burden than the average 
person who may not be buying car insurance, homeowner's 
insurance, having to develop property, whatever.
    So I guess I do not find a great deal of--I do not have a 
real problem looking at the issues of public policy issues, 
saying a portion of this rightfully may belong to the 
Government, may be spread among taxpayers at large, and not 
require the repayment, which essentially gets transferred 
through higher premiums over a longer period of time just to 
insure the public.
    Chairman Sarbanes. Mr. McCool, do you have an analysis?
    Mr. McCool. In most of these issues, the GAO would prefer 
that the Government not be--I agree with Ms. Sebelius. You 
really are to some extent talking about over what base you are 
spreading the increase. There is probably a fairly large 
overlap between the taxpayers and the people who pay for 
insurance. It is not 100 percent, but it is probably fairly 
high.
    Mr. Hunter. But there is also a question of equity, of 
course. And that is, the people with the higher risks pay 
higher premiums and particularly will pay higher terrorism 
premiums in the future. And they will then bear the 2 percent 
per year burden more heavily than the average taxpayer. And 
that is fairer because they are the ones with the exposure.
    Senator Miller. One more question, Mr. Hunter. Let us say 
that the plan, as you put it, is not adopted. And instead, what 
is passed is something like what the Administration has 
offered. In your opinion, what kind of oversight capacities 
would be necessary for the Federal Government to engage in that 
kind of temporary reinsurance commitment with the private 
sector?
    Mr. Hunter. Well, first of all, you would have to write 
reinsurance contracts with the insurance companies because they 
would not certainly--they would want to have certainties, so 
they would want a policy. Even though there was no premium, I 
guess, you would still have to have some kind of a legal 
document that you would work with them that would define 
terrorism and explain who decides what. You would have to have 
a system of auditing the claims. You would have to have a 
bureaucracy. Claims is fairly complex. And of course, you would 
not ever get the taxpayer reimbursed, is my key problem with 
that system.
    But I do think that--
    Senator Miller. There are no oversight provisions that you 
would propose that we write in there?
    Mr. Hunter. I still think that you could rely a lot on the 
States, although there is a lot of preemption in the insurance 
proposal of State regulations, so you would need some Federal 
thing to take the place of that in the insurance industry 
proposal.
    But in the Administration proposal, there seems to be less 
override of the States. So you could still task the States with 
various things like assuring affordability, availability, 
making sure that there are surcharges or discounts that would 
enhance security. I think some of those things could be added 
to the Administration proposal.
    Senator Miller. Are you saying they should be added or 
could be added?
    Mr. Hunter. Should be.
    Chairman Sarbanes. Well, now, the Administration's own 
proposal has them withdrawing after 3 years, apparently on the 
premise that reinsurance would then be available to the primary 
carriers. Is that how you understand it?
    Mr. Hunter. Yes.
    Chairman Sarbanes. If you got through that period without a 
major terrorism attack, then the whole thing would be back in 
the private market and there would have been no Government 
cost. Correct?
    Mr. Hunter. Right. You still have to have the 
administrative costs of running the program.
    Chairman Sarbanes. Those would be relatively 
inconsequential.
    Mr. Hunter. Right. Yes.
    Chairman Sarbanes. Now what do you all think, if you read 
about this proposal that the insurance companies put forward.
    Mr. Hunter. I will start. It is terrible. I have a long 
list of complaints about it in my written testimony, including 
the fact that it is not an actuarially sound program because it 
has no premium the first year. Additionally, it allows 
``cherry-picking'' of the worst sort. That is, individual 
companies can opt in or out of the plan. And the individual 
companies within a group can individually opt in and out of the 
plan.
    So if you have these target risks that we have been talking 
about, you can put one company, reinsure that one with the 
Federal Government, and leave all your good business not for 
the Federal Government. And I do not believe the Federal 
Government should be put in a position of the taxpayers only 
picking up the bad risks and having the good risks left for the 
private sector.
    The selection of Illinois as the sole regulator and 
creating, in effect, a cartel at the front end in Illinois, and 
overriding the bill, not only would there be no rate 
regulation, but there will be no residual Federal or State 
antitrust law enforcement against it. So it waives all those. 
There is no guarantee of affordability or availability and so 
on, and it is a very large overreach by the industry with a lot 
of their wish list in it.
    Chairman Sarbanes. Mr. McCool.
    Mr. McCool. Well, again, we have----
    Chairman Sarbanes. What does your analysis show? I know you 
have to frame it in terms of analysis.
    Mr. McCool. I was going to say, our list of concerns is not 
quite as long. But we are concerned about the pooling 
arrangement being in one State. Again, there is a certain 
monopolistic element to that.
    There are again concerns about, in this case, what I guess 
would be ``cherry-picking'' as opposed to some other 
arrangement that we were talking about earlier. It is a 
problem, but it is a different one, that you could end up with 
the better risks in the pool and the worst risks outside the 
pool.
    Chairman Sarbanes. Ms. Sebelius.
    Ms. Sebelius. Well, I think Mr. Hunter outlined a number of 
the key issues that would be of grave concern to regulators, 
``cherry-picking'' not the least among them. The antitrust 
provision, there is fairly broad preemption of State laws and 
regulations.
    We think it would abdicate a lot of consumer protection 
initiatives that are currently in place and they would cease to 
exist.
    And I think the mandating of the pooling arrangement--I do 
think the industry has a keen interest in pooling risk, but it 
is something that we feel could be accomplished voluntarily. 
That is part of the kind of regrouping mechanism that they 
could go through. And I am not sure that you need a Federal law 
or a kind of bureaucratic structure to have that done and 
create a new company. I think that is very much a private 
market phenomenon that will happen.
    Chairman Sarbanes. Well, one of the issues that is raised 
here in the backdrop, so to speak, is, as you say, the 
preemption of various State requirements that have heretofore 
applied to the insurance industry.
    Now, if that is going to happen, it seems to me, 
particularly if you are asking for a major contribution of 
resources from the Federal Government, there is going to have 
to be monitoring and oversight and, indeed, regulation at the 
Federal level. So I think one of the issues here is whether we 
are going to start down this path of altering the Federalism 
arrangement with respect to insurance.
    Now I am prompted to say that because there are people 
moving around the halls of the Congress who want to do Federal 
insurance charters and so on. That is an issue, it seems to me, 
with far-ranging implications, which would need to be addressed 
on their own terms. I do not think we want to do it through the 
back door on a terrorism bill. So, presumably, the Association 
of Insurance Commissioners has some concern about that issue. 
Am I correct?
    Ms. Sebelius. I think that is safe to say.
    [Laughter.]
    That we do have concern. We think, Senator, that the 
ability of the industry to pay the September 11 events is a 
strong testimony to the fact that the regulatory system in 
place works. The reserves are there. The companies are 
capitalized. They are monitored. The claims are going to be 
paid.
    We think what you are looking at at this instant is a 
short-term problem dealing with recapitalization and 
availability of what is a bit of an unknown risk up until 
September 11. Hopefully, we will not know a lot more about it, 
but we can price it more accurately going forward.
    A lot of the monitoring and oversight I think that would be 
required for any kind of Federal involvement frankly is in 
place right now around the country and could be detailed to the 
States to go ahead and do, following up on claims payments, 
auditing. Those are things that we have experts doing as we 
speak. We have actuaries. We have a variety of technical staff, 
both at the national office and locally.
    We think it is appropriate in terms of preemption issues 
that you look at things like, one, uniform definition of 
terrorism. You clearly could not have 50 different definitions 
floating around. In fact, we have a group working on that very 
issue because we think we are going to need that one way or the 
other.
    The issue about whether or not all companies would be 
required to, or would be disallowed from having terrorism 
coverage, is an issue that may appropriately rest with you.
    So there are some issues that we would be very supportive 
of having uniform definitions across the country put in place 
very quickly. But in terms of a long-term need to either 
duplicate or preempt the State system that functions very well, 
we would urge you not to use this opportunity as a way to sweep 
away what is a 100-plus year-old regulatory system that 
actually functions pretty well. Totally unforeseen loss, nobody 
could have predicted it. They are up at the table paying the 
claims, and I think that is testimony to the fact that it 
actually works.
    Chairman Sarbanes. Does anyone else have any observation on 
that issue?
    [No response.]
    Now let me ask this question.
    Mr. Hunter. Let me just say, there is no question that if 
you adopt something like the industry approach, I think you 
have to get in there because, otherwise, there is going to be 
nobody checking the rates or anything. And you had better get 
in there because, otherwise, you are going to be handing away 
all this free insurance by taxpayers and you are not going to 
have any guarantee that the prices are affordable or anything. 
You need, it seems to me, some way of assuring that.
    Chairman Sarbanes. I take it all three of you would rate 
the Administration's proposal above the insurance industry's 
proposal, as you know those proposals. Is that correct?
    Ms. Sebelius. Yes.
    Mr. McCool. [Nods in the affirmative.]
    Mr. Hunter. [Nods in the affirmative.]
    Chairman Sarbanes. And I take it that all three of you 
would also--there are modifications you feel can be made to the 
Administration's proposal which would make it better than it 
is. Is that correct as well?
    Ms. Sebelius. Yes.
    Mr. McCool. [Nods in the affirmative.]
    Mr. Hunter. [Nods in the affirmative.]
    Chairman Sarbanes. Well, this has been a very helpful 
panel. I hope we can continue to call on you for your counsel 
and advice as we wrestle with this issue. You can be very 
helpful to the Committee. And, of course, the State insurance 
commissioners have a tremendous amount of expertise built up 
over the years. And Mr. McCool, we always look to the GAO 
around here. And Mr. Hunter, you have actually come in with 
some very imaginative and helpful suggestions. And so, we will 
continue to work with this issue.
    Ms. Sebelius. Senator, we look forward to working with the 
Committee, with the Administration, on moving this issue 
forward. We think it is a high priority and we do think it is 
appropriate that the Federal Government play a role, and it is 
probably got to be done pretty quickly, given our timetable 
issue. But we look forward to helping in any way we can. We do 
have a lot of technical expertise that we would be happy to 
lend to the process.
    Chairman Sarbanes. I think, as we think about it, we need 
to try to--well, you can never deal with a complex issue 
necessarily in a simple way. I understand that complexity has 
to be met to some extent with complexity.
    On the other hand, we need to get this thing down to the 
essentials and deal with the essentials. We need to push back 
overreaching, if that is, in fact, occurring.
    And I do not know that we can take on other agendas that 
people of one sort or another that have been hanging around 
here and have not been acted upon, and then they fasten upon 
this vehicle to move that agenda. That is not what we are 
about. We are willing to try to address what everyone has said 
needs to be addressed on the problem. But if people start 
piling in on this, either with some long-standing agenda or 
seeking to overreach on the relevant agenda, we are going to 
have difficulty. We have to work through this toward a 
consensus we can close ranks on and move ahead.
    But your testimony has been very helpful. And again, I want 
to express my appreciation. I know that people were given a lot 
of time to prepare and obviously, a great deal of care and 
thought has gone into these statements.
    The Committee will resume its session. We will reconvene 
tomorrow morning at 10 a.m. in this room. The Dirksen Building 
where the Committee's hearing room is has not yet been opened. 
It may be opened by the end of the week or the first of next 
week. The Russell Building has been opened and the Hart 
Building apparently, which is where the Daschle office was and 
so forth, will remain closed while they continue to carry 
through on the environmental check-out.
    Tomorrow, we have two panels. Panel One is: Robert Vagley, 
President of the American Insurance Association; Ron Ferguson, 
the CEO of General Ray, representing the Reinsurance 
Association of America; and John T. Sinnott, the CEO of Marsh, 
Inc., representing the Council of Insurance Agents and Brokers. 
That will the first panel.
    And the second panel will be: Tom Donohue, President and 
CEO of the Chamber of Commerce; Ellen Baker, Chairman of 
Wacovia Corporation, who will be speaking for the Financial 
Services Roundtable; and Thomas Carr, President and CEO of Carr 
America Realty Corporation, representing the National 
Association of Realty Investment Trust.
    And that will obviously give us an opportunity to hear from 
both the insurance industry itself and then the second panel, 
from broader representatives of the business community. I know 
it has been a long day for you. We very much appreciate your 
staying with us.
    The Committee is adjourned until tomorrow at 10 a.m.
    [Whereupon, at 4 p.m., the hearing was adjourned.]
    [Prepared statements and additional materials supplied for 
the record follow:]
               PREPARED STATEMENT OF SENATOR JIM BUNNING
    I would like to thank you, Mr. Chairman, for holding this important 
hearing, and I would like to thank Secretary O'Neill and Chairman 
Hubbard for testifying today. The tragic events of September 11 have 
had many repercussions. In addition to the obvious losses to those 
directly affected, the attacks wreaked havoc throughout our economy. 
One critical part of the economy the attacks have affected is the 
insurance industry. I am very grateful that Secretary O'Neill and 
Chairman Hubbard were able to come before this Committee and explain 
the Administration's insurance proposal. I believe there is a serious 
problem facing us that must be addressed by January 1. As my colleagues 
know, many insurance policies will be up for renewal on January 1.
    If Congress does nothing, many of these policies will not be 
renewed, and many businesses and properties will not be able to 
purchase insurance. The Administration has a proposal that frankly 
gives me some heartburn. However, something needs to be done and done 
quickly and I have not seen a better plan. Hopefully today we can start 
to come up with some better ideas. However, I do agree with the 
Administration that there must be a sunset on assistance we give the 
insurance and reinsurance industry. This is absolutely critical. We 
must allow the market to figure out how to price this new risk.
    We can help give the industry time to sort this out and collect 
data, but we can not set the market. We also must make sure this is not 
a way to create a back-door federalization of insurance. I know there 
are many in Congress who would like a Federal insurance charter and a 
greater Federal involvement in insurance, but this is neither the time 
nor the place. It is also crucial that we make sure the industry 
assumes some of the risk. We cannot ask the taxpayer to pick up the 
entire bill.
    I believe it is crucial that we act thoughtfully and we act 
quickly. We must do what we can to avoid the unintended consequences 
that could harm our vibrant insurance industry but we must also assist 
the industry so they can figure out how to price this new risk before 
the end of the year. If we do not, not only will we have businesses 
failing because of a lack of insurance, we may have the taxpayer 
completely on the hook if another catastrophic event hits our county, 
be it act of God or act of evil.
    Thank you, Mr. Chairman.
                               ----------
                   PREPARED STATEMENT OF BILL NELSON
                A U.S. Senator From the State of Florida
    Chairman Sarbanes, Members of the Committee, thank you for inviting 
me to address one of the many challenges facing us in the wake of the 
terrorist attacks on September 11, and the bioterrorism attacks since 
then. I hope my prior experience as Florida's insurance commissioner 
will be helpful as we grapple with the challenge ahead, which is to 
protect all of America's insurance consumers by making sure coverage 
remains available and affordable to protect them against such 
despicable acts.
    We all know that insurance is one of the crucial engines of our 
economy. Without it, banks will not make loans for real estate or other 
ventures, and businesses will not invest or expand. Millions of jobs 
would be lost as the impact rippled through our economy. We cannot let 
that happen. Neither can we allow the insurance industry to use the 
September attacks as an excuse to shirk its rightful role and 
responsibilities. Already, reinsurance and insurance companies are 
saying they no longer will cover terrorist attacks after December 31 . 
. . when about 70 percent of the commercial insurance contracts in the 
United States are scheduled to expire.
    I do not doubt that the industry's problem is genuine. In the 
immediate aftermath of September 11, it is virtually impossible for 
insurers to calculate their potential liability in the face of possible 
future terrorist attacks. But we cannot allow ourselves to be held 
hostage by high-pressure tactics of any industry.
    Nor can we make the same mistakes we made with the airline 
industry. In that legislation we did not hold the industry's feet to 
the fire and make sure that they took care of their employees and the 
consumers.
    I know from our experience in Florida that the insurance industry 
is more than willing to walk away from its biggest risks and turn them 
over to somebody else. Companies paid out $16 billion in claims after 
Hurricane Andrew slammed across South Florida in 1992--the costliest 
natural disaster ever. Then major players in the industry spent the 
rest of the decade trying to slip through State legislation that would 
shift responsibility for hurricane coverage to Florida's government and 
its taxpayers. We headed off every one of those efforts. And we fought 
the industry's attempts, since Andrew, to force unconscionable, ever-
increasing rates on Florida's homeowners.
    Homeowner insurance rates are now stabilized in Florida, and 
competition has returned--because we worked out a solution that will 
back up the industry if and when another mega-storm hits. But the 
emergency fund created by the State requires companies to pay for most 
hurricanes and to shoulder their share of cost of major storms. And it 
spreads the risk by building up reserves with premium dollars--not 
taxpayers' dollars.
    Whatever solution we come up with at the Federal level on terrorist 
coverage, I believe the same principles of private enterprise must be 
applied. Government can play an important role in helping to resolve 
the immediate crisis--whose impact would be felt far beyond the 
insurance industry. For the most part, however, we should leave the 
business of insurance to the insurance business.
    As you know, there are two basic plans so far--the White House 
proposal and another plan that seems to have broad support from the 
insurance industry. They are still being fleshed out, so we do not have 
the details needed to fully and fairly judge them. But, based on the 
information that has emerged so far, I have some major concerns. For 
example, what safeguards would be provided to prohibit insurers from 
doing what the industry calls ``cherry-picking?'' In other words, once 
Federal help is provided, what is to stop the companies from covering 
only those properties or businesses that are relatively safe from 
terrorism and leaving the bigger risks for someone else? And, what is 
to stop them from simply passing on any terrorism losses they might 
suffer in the form of sudden and steep surcharges against their 
customers? Or from finding ways, in the complex array of State 
regulations, of excluding acts of terrorism from the coverage consumers 
buy on their homes, their automobiles, or their lives?
    I say that anything we do here, at the Federal level, must assume 
and require that companies cover the peril of terrorism--a peril that 
looms so much larger since September 11. Simply put, if taxpayer's help 
foot the bill, then the terrorism peril cannot be dumped by the 
insurance industry.
    As I understand it, the Administration's plan would make the 
Federal Government responsible for paying 80 percent of the first $20 
billion in claims, and 90 
percent of the next $80 billion, resulting from any terrorist attacks 
in 2002. This proposal would increase the industry's liability from 
terrorist claims in the next 2 years, but still cap it at $23 billion 
in 2003, and $36 billion in 2004, with the Federal Government covering 
all remaining claims. I have strong concerns about requiring the 
taxpayers to assume, even on a temporary basis, such a large percentage 
of the cost--especially at the front end.
    A more responsible approach, in my view, would be to require the 
companies to, cover terrorist-related losses up to a certain level 
before any Federal help would kick in. The primary insurer would cover 
up to a certain dollar retention level, and above that level, the risk 
could shift to the Federal Government. We should not support any 
proposal involving the use of taxpayer dollars unless we are convinced 
that the insurance companies have ample ``skin in the game.''
    Under the separate, industry-backed proposal, insurers would pool 
their premiums through creation of a new Government-backed insurance 
company called the Homeland Security Mutual Reinsurance Company. Each 
participating company would retain 5 percent of terrorism and 5 percent 
of workers' compensation war risk, and leave the remaining 95 percent 
of each to the insurance pool.
    I hold true to the belief that private market solutions are more 
desirable than Federal intervention. But--if I understand this plan 
correctly--the Federal Government would be responsible for covering 100 
percent of any claims resulting from terrorism next year, while the new 
insurance pool begins building its capital.
    As this debate progresses, we must constantly keep in mind that 
insurance companies are well equipped to handle most large-scale 
disasters. The industry is recognized by many financial rating 
agencies, institutional investors, and economists as one of the 
strongest in the global economy.

 Between them, the property-and-casualty and life-and-health 
    insurance industries count nearly $3 trillion in invested assets.
 The National Association of Insurance Commissioners estimates 
    that the industry has a capital cushion of more $550 billion to 
    absorb unexpected downturns in the financial markets and adverse 
    loss experience on its policies.

    In other words, the industry is flush right now with huge 
surpluses. And, whatever our solution to this aspect of the terrorist 
crisis, we must require insurers to pay their fair share. As we 
consider the public policy implications of terrorism reinsurance, I 
believe we must proceed in a deliberative fashion. In my view, that 
means reaching agreement in the coming weeks on a short-term, interim 
solution--no more than 1 year--to ensure that insurance protection 
against terrorist attacks remains available in 2002. And then resuming 
our work after January 1 to develop a more permanent plan.
    That approach also would enable us to consider reform of the 
current system of insuring against natural catastrophic disasters. 
Despite our progress in Florida in dealing with the hurricane threat, 
the fact remains that no single State, nor any single industry, could 
cope with the kind of mega catastrophe we now know Mother Nature could 
bring our way.
    In lieu of the perennial debate over establishing a Federally 
backed insurance pool, I am personally intrigued by proposals that 
would require insurers to set aside part of their profits for a rainy 
day. The idea is to let companies develop tax-deferred reserves and 
thereby increase their capacity to respond to catastrophic losses. I 
know this Committee takes a keen interest in these problems, as does 
the Commerce Committee.
    I look forward to working with you on legislation--both short- and 
long-range solutions--that not only will keep our economic engines 
running but also protect the consumers we all serve.
                               ----------
                 PREPARED STATEMENT OF PAUL H. O'NEILL
               Secretary, U.S. Department of the Treasury
                            October 24, 2001
    Mr. Chairman, Senator Gramm and Members of the Committee, I 
appreciate the opportunity to comment on terrorism risk insurance. 
These hearings are extremely important. We believe that there is a real 
and pressing need for Congress to act on this issue now. As I will 
discuss in more detail, market mechanisms to provide terrorism risk 
insurance coverage have broken down in the wake of September 11. Such 
coverage is now being dropped from property and casualty reinsurance 
contracts as they come up for renewal, with most policies renewing at 
year-end. If Congress fails to act, reinsurers have signaled their 
intention to exclude such coverage meaning that primary insurers may 
have to drop this coverage or institute dramatic price increases. As a 
result, after January 1 the vast majority of businesses in this country 
are at risk for either losing their terrorism risk insurance coverage 
or paying steep premiums for dramatically curtailed coverage. This 
dynamic can, in turn, be expected to cause dislocations throughout our 
economy, particularly in the real estate, transportation, and energy 
sectors.
The Problem
    The terrorist attacks of September 11 created widespread 
uncertainty about the risk and potential costs of future terrorist 
acts. Since September 11, we have endured this uncertainty every day as 
a country. It has permeated every sector of our economy.
    A key part of the Federal Government's response to the events of 
September 11 is to ensure that our economic stability is not undermined 
by terrorist acts. Continued economic activity is dependent on well 
functioning financial markets--where the lifeblood of capital is 
provided to business enterprises. Financial markets allocate capital 
based on the potential success of a business. In doing so, financial 
markets rely on the insurance sector to mitigate certain types of risk 
that are not directly related to the plans or operations of a business.
    Insurance companies manage risk in economic activity and facilitate 
the efficient deployment of capital in our economy by estimating 
probabilities of possible adverse outcomes and pooling risk across a 
large group. Since September 11 the uncertainty surrounding terrorism 
risk has disrupted the ability of insurance companies to estimate, 
price, and insure the risk.
    We learned on September 11 that, while perhaps highly improbable, 
terrorists are capable of enormous destruction. Could such an event be 
repeated? As a country and a Government, we are doing everything in our 
power to prevent a repetition of anything like the events of September 
11. But how does an insurance company assess this uncertainty? How does 
an insurance company price for it? At the moment, there are no models, 
no meaningful experience, no reasonable upper bound on what an 
individual company's risk exposure may be.
    Insurance companies do not ``take'' risks. They knowingly accept 
and mutualize risks. They are private, for-profit enterprises. If they 
do not believe they can make money by underwriting a particular risk, 
they will not cover it. Because insurance companies do not know the 
upper bound of terrorism risk exposure, they will protect themselves by 
charging enormous premiums, dramatically curtailing coverage, or--as we 
have already seen with terrorism risk exclusions--simply refusing to 
offer the coverage. Whatever avenue they choose, the result is the same 
increased premiums and/or increased risk exposure for businesses that 
will be passed on to consumers in the form of higher product prices, 
transportation costs, energy costs, and reduced production.
    The consequences of uncertainties surrounding terrorism risk are 
already evident in the airline sector. The Department of 
Transportation's initial projection is that, as a result of the 
September 11 attacks, airlines will pay nearly $1 billion in premium 
increases for terrorism risk insurance in the next year despite a 
congressionally imposed cap on third-party liability. Within the next 
few months, similar 
increases can be expected for other forms of economic activity deemed 
``high risk''--if coverage is available at all. Higher premiums will 
divert capital away from other forms of business investment.
    The need for action is urgent. From our conversations with 
insurance company representatives, State insurance regulators, 
policyholders, banks, and other entities which provide financing for 
property transactions, the next 2 months are critical. The insurance 
industry relies on a complicated structure of risk sharing. Risk is 
shared among primary insurers, reinsurers, and retrocessionairs (that 
is, providing reinsurance to the reinsurers). This structure has worked 
well in the past and greatly contributed to widely spreading losses 
associated with the events of September 11 across the insurance 
industry.
    However, in light of the uncertainty created by September 11, 
reinsurers have told us that they will no longer cover acts of 
terrorism in their reinsurance contracts with primary insurers. And as 
I have said, most property and casualty insurance contracts are up for 
renewal at year end. This will create the following choices for 
insurers: assume all of the risk of terrorism coverage and raise prices 
to cover all of the associated, unshared costs; reduce coverage levels; 
or cancel coverage. Any of these choices has the potential to cause 
severe economic dislocations in the near-term either through higher 
insurance costs or higher financing costs.
Objectives
    In grappling with this problem, we have had several objectives. 
First and foremost, we want to dampen the shock to the economy of 
dramatic cost increases for insurance or curtailed coverage. We also 
want to limit Federal intrusion into private economic activity as much 
as possible while still achieving the first objective. And we want to 
rely on the existing State regulatory infrastructure as much as 
practicable. Note that none of these objectives are directed at 
providing Government assistance to the insurance industry. The industry 
is absorbing the financial losses it contracted for as a result of the 
September 11 attacks, and is fully capable of making good on those 
losses. The industry is also capable of continuing to provide insurance 
for nonterrorist hazards. The problem, as I have said, is one of 
uncertainty about future terrorist risk. At the moment, there is no 
basis upon which to price terrorism risk and no sense of the upper 
bound on the risk exposure.
Options
    Over the past few weeks, a variety of proposals have emerged to 
deal with the problem I have outlined. Before turning to the approach 
we have developed, I will briefly discuss a few of the alternatives we 
considered and some of the shortcomings we identified with each.
    A case could be made to treat terrorism risk insurance like war 
risk insurance. During World War II, the Federal Government provided 
property owners with insurance protection against loss from attack. 
Similarly, the Israeli Government provides insurance for terrorism 
risk. This approach would recognize the terrorist threat as one made 
against all Americans and would establish the broadest possible risk 
pool for insuring against this risk. At the same time, such an approach 
implies a permanent Federal intrusion in the market so long as any 
terrorism risk remains.
    A second approach, one suggested, in various forms by insurance 
industry representatives, involves the creation of a reinsurance 
company to pool terrorism risk. This model follows an approach 
developed in the United Kingdom in response to IRA terrorist 
activities. This approach has some appeal, especially in providing a 
vehicle for pooling the industry's risk while providing an upper bound 
on industry losses through a Government backstop. With more time, or in 
different circum-
stances, this approach may have been desirable.
    In our judgement it has several significant shortcomings. First, 
the approach ultimately leads to the Federal Government setting premium 
rates by establishing the rate charged to the pool for the Government's 
backstop. If the basic problem is that the insurance industry whose 
business it is to measure and price risk--cannot currently price 
terrorism risk without distorting markets, why would we think the 
Government can do a better job?
    Establishing a pool would also take time, and time is very limited 
since most policies expire at year-end. It is unclear how long it would 
take industry to capitalize the pool. In the interim, the Government's 
exposure could be substantial, insofar as it would be liable for 100 
percent of losses that exceeded the pool's capitalization. In addition, 
we question whether the Government could move quickly enough on its end 
to establish the contracts, the pricing structure, and the regulatory 
structure needed to make the proposal work.
    Finally, the pool approach creates a Federal insurance regulatory 
apparatus with some presumption of permanence and a potentially 
enormous pool of captive capital that we may never need to use. We 
believe that there will be less uncertainty about terrorism risk a few 
years from now and that uncertainty will be more manageable by the 
private sector than is the case today. Given that, why undertake the 
effort to create a monopoly reinsurer and give a new Federal regulator 
the power to both set prices and regulate insurance companies and their 
activities?
    A third option would be to simply set a large industry deductible 
and let the Federal Government cover all losses from acts of terrorism 
past that point. For instance, the Federal Government could require the 
insurance industry to cover all losses up to, say, $40 billion in a 
given year and the Federal Government would pay all losses above that 
amount.
    This approach has two substantial drawbacks. First, it does not 
address the fundamental problem: the industry has no basis for 
knowing--and hence pricing--terrorism risk. A large deductible would 
require them to assess premiums large enough to cover a large potential 
loss. In the absence of better information, we might well expect 
companies to price insurance as if they fully expected losses up to the 
deductible amount. Second, this approach makes it difficult to control 
losses above the deductible as insurance companies would have no 
incentive to limit costs once their deductible has been paid.
A Shared Loss Compensation Program
    After reviewing these and other options, and discussing these 
issues with Congressional and industry leadership and the State 
insurance regulatory community, we developed an approach that we 
believe best accomplishes the objectives I set forth. Let me say at the 
outset that this approach reflects the current evolution of our 
thinking on this issue. We want to work with Congress to achieve the 
best possible solution. As I have said, the insurance industry can 
easily protect itself by eliminating coverage or charging very high 
premiums. What we are trying to do is craft a plan that will prevent 
the economic dislocations that will otherwise take place if private 
insurers follow the course they are now on. It is imperative that we 
find a solution that works in the marketplace. We must get it right, 
and we must get it right now.
    When terrorists target symbols of our Nation's economic, political, 
and military power, they are attacking the Nation as a whole, not the 
symbol. This argues for spreading the cost across all taxpayers. Yet 
there are also reasons to limit the Federal role. If property owners do 
not face any liability from potential attacks, they may underinvest in 
security measures and backup facilities. In addition, the insurance 
industry has sufficient experience and capacity to price some portion 
of the risk associated with terrorism and has the infrastructure 
necessary to assess and process claims.
    Under the approach we are suggesting, individuals, businesses, and 
other entities would continue to obtain property and casualty insurance 
from insurance providers as they did before September 11. The terms of 
the terrorism risk coverage would be unchanged and would be the same as 
that for other risks.
    Any loss claims resulting from a future terrorist act would be 
submitted by the policyholder to the insurance company. The insurance 
company would process the claims, and then submit an invoice to the 
Government for payment of its share.
    The Treasury would establish a general process by which insurance 
companies submit claims. The Treasury would also institute a process 
for reviewing and auditing claims and for ensuring that the private/
public loss sharing arrangement is apportioned among all insurance 
companies in a consistent manner. State insurance regulators would also 
play an important role in monitoring the claims process and ensuring 
the overall integrity of the insurance system.
    Through the end of 2002, the Government would absorb 80 percent of 
the first $20 billion of insured losses resulting from terrorism and 90 
percent of insured losses above $20 billion. Thus, the private sector 
would pay 20 percent of the first $20 billion in losses and 10 percent 
of losses above that amount.
    Under this approach the Federal Government is absorbing a portion--
but only a portion--of the first dollar of losses, which we believe is 
important to do in the first year of the program. The key problem faced 
by insurance companies right now is pricing for terrorism risk. While 
this type of loss sharing approach does not completely alleviate that 
problem, it does provide insurance companies with the ability to 
evaluate potential losses on a policy-by-policy basis, with clearly 
defined maximum exposures. For example, on a $100 million commercial 
policy the insurance company's maximum exposure would be $20 million. 
If industry losses were greater than $20 billion that exposure would be 
reduced even further.
    More importantly, price increases to policyholders should be lower 
under this approach than under an approach that requires companies to 
absorb 100 percent of losses up to a large, aggregate industry loss 
deductible. Under this approach, if an insurance company's maximum 
exposure was defined at $20 million on a $100 million policy, the 
insurance company could then price that $20 million exposure on the 
probability of a complete loss event occurring.
    Suppose instead that the insurance industry had to absorb $20 
billion in losses before any Government loss sharing began. Then, in 
our example, the insurance company's maximum loss exposure would be 
$100 million on that policy, not $20 million. Pricing to this maximum 
loss would create the economic dislocation we are trying to avoid.
    The role of the Federal Government would recede over time, with the 
expectation that the private sector would further develop its capacity 
each year. As private sector capacity increases, the nature of the 
Government's loss sharing agreement would also change. Given more time 
and experience, we believe that the insurance industry could 
reestablish robust risk-sharing arrangements such as reinsurance that 
would enable the private sector to insure losses from terrorism before 
the Government loss sharing commenced.
    Thus, in 2003, we would have the private sector be responsible for 
100 percent of the first $10 billion of insured losses, 50 percent of 
the insured losses between $10 and $20 billion, and 10 percent of the 
insured losses above $20 billion. The Government would be responsible 
for the remainder.
    In 2004, the private sector would be responsible for 100 percent of 
the first $20 billion of insured losses, 50 percent of the insured 
losses between $20 and $40 billion, and 10 percent of the insured 
losses above $40 billion. The Government would be responsible for the 
remainder.
    To preserve flexibility in an extraordinary attack, combined 
private/public liability for losses under the program would be capped 
at $100 billion in any year. It would be left to Congress to determine 
payments above $100 billion.
    The Federal Government's involvement would sunset after 3 years. It 
is our hope, indeed our expectation, that the market problem we face 
today will have been corrected by then so that the private sector will 
be able to effectively price and manage terrorism risk insurance going 
forward. Of course, should that prove not to be the case, Congress and 
the President can reevaluate the program in place and decide at that 
time on an extension of the program or establishment of another 
approach.
    This approach would also provide certain legal procedures to manage 
and structure litigation arising out of mass tort terrorism incidents. 
This includes consolidation of claims into a single forum, a 
prohibition on punitive damages, and provisions to ensure that 
defendants pay only for noneconomic damages for which they are 
responsible. It is important to ensure that any liability arising from 
terrorist attacks results from culpable behavior rather than 
overzealous litigation. These procedures are important to mitigating 
losses arising from any future terrorist attack on our Nation, and are 
an absolutely essential component of the program I have outlined.
    Finally, this approach requires a clear definition of an ``act of 
terrorism.'' We suggest that the Secretary of the Treasury, with the 
concurrence of the Attorney General, and in consultation with other 
members of the Cabinet, be given authority to certify that a terrorist 
act had taken place for purposes of activating the shared loss 
compensation arrangement.
    We believe that this approach dampens any adverse economic impact 
from a sudden increase in the cost from terrorism risk insurance over 
the next 12 months. The imposition of a deductible in the second year, 
and an increase in the deductible in the third year, permits the 
Federal Government to gradually withdraw from the market as the private 
sector adapts to measuring and pricing terrorism risk.
Conclusion
    Mr. Chairman, for the reasons I have set forth, the Administration 
believes that the economy is facing a temporary, but critical, market 
problem in the provision of terrorism risk insurance. Keeping our 
economy moving must be our overriding concern. Leaving this problem 
unresolved threatens our economic stability. The approach I have 
outlined limits the Government's direct involvement, retains all those 
elements of our private insurance system that continue to operate well, 
and provides a transition period to allow the private sector to 
establish market mechanisms to deal with this insidious new risk that 
confronts our Nation.
    There are no perfect solutions to this problem. We have developed 
what we believe is a sound approach. As I explained earlier, we do not 
believe that creation of a reinsurance pool can be accomplished under 
the time constraints we face, but we would be glad to explore 
modifications to our approach with the Committee.
    I would be pleased to answer any questions the Committee may have.
                               ----------
                 PREPARED STATEMENT OF R. GLENN HUBBARD
                 Chairman, Council of Economic Advisers
                            October 24, 2001
    Mr. Chairman, Senator Gramm, and Members of the Committee, I 
appreciate the opportunity to appear before you today to discuss the 
situation facing insurance markets in the context of the current 
terrorist threat. In a very real sense, the timing of these hearings is 
significant; it is important that Congress act on the issue of 
terrorism risk insurance before the end of the year.
    The terrible tragedy associated with the terrorist attacks on New 
York and Washington exacted an economic toll on the United States as 
well as a human toll, and the Administration is working with Congress 
to address both losses. Among the direct repercussions of these attacks 
has been an increased appreciation of the need to focus public policy 
on security, including efforts toward defending American economic 
activity against terrorist intrusions. The need for security in 
economic activity--whether in such visible forms as Federal Air 
Marshals or more mundane needs like additional backup computer systems 
raises the overall cost of transacting business. In this sense, the 
attacks acted as a shock to the costs of supplying goods and services 
in the economy. It is in our economic interest to contain these 
transactions costs as much as possible.
    The attacks also raised the degree of uncertainty in the economic 
environment--from the state of aggregate demand, to the demand for 
particular goods and services (air travel, for example), to a myriad of 
other areas. Commercial insurance lies at the intersection of these two 
forces. Property and casualty insurance is one mechanism by which 
economies respond efficiently to risks in the environment. Risks are 
spread, converting for each business a potential cost of unknowable 
size and timing into a set of smaller, known premium payments. The 
events of September 11 induced a dramatic revision in perceived risks. 
In normal circumstances, increased risks are translated into higher 
premiums. This serves the useful economic function of pricing risk, 
leading the private sector toward those activities where the risk is 
``worth it''--there might be losses now and then, but on average 
society will benefit--and away from foolhardy gambles.
    At the moment, however, the entire Nation is unsure of the genuine 
likelihood of additional terrorist events. For insurance markets, 
unfortunately, the distinction between risk not knowing when an event 
will happen, but having solid knowledge of the odds of an occurrence--
and genuine uncertainty about the frequency of an insured event is the 
key to being able to price efficiently. Experience with our new 
security environment will mitigate this difficulty over time. In the 
near term, however, it would not be terribly surprising to experience 
disruption of the property and casualty market. In the extreme, 
customers may not be able to renew policies until the market resolves 
pricing difficulties. That is, reinsurers may no longer cover acts of 
terrorism in their reinsurance contracts with primary insurers.
    An interruption of coverage is a particular, and extreme, version 
of an increase in transactions costs as a result of terrorist-
associated risks. Still, there is the possibility that existing lines 
of coverage will be renewed only with quite substantial increases in 
premiums. I believe we are all now familiar with the difficulties 
facing aviation; disproportionate rises in insurance coverage or, in 
the extreme, withdrawal of insurance coverage, would hinder transition 
to a new operating environment. This phenomenon is more widespread, 
however. Lenders usually require businesses to insure any property they 
use to secure loans. The terms of terrorism coverage could diminish 
bank lending for new construction projects. It could as well act as a 
sharp impediment to transactions that permit existing, commercial 
properties--skyscrapers, pipelines, power plants, and so forth--to 
change hands. It is important to point out that this ``changing hands'' 
is an important economic function. The relative efficiency with which 
our economy reallocates capital from less productive to more productive 
uses sets it apart from many other nations.
    In short, a well-functioning insurance market is part of the 
financial infrastructure that underpins our economy. The Administration 
and Congress worked together to restore the institutional underpinnings 
of the financial markets in the week after September 11. In the same 
way, the Administration looks forward to working with the Congress to 
bolster the capacity of private insurance markets to provide the risk-
sharing services that benefit commerce and consumers.
Principles for Government Involvement
    To this end, the Administration believes that any Federal 
intervention in the insurance market should adhere to four key 
principles:

    1. Intervention should encourage, not discourage, private market 
incentives to expand the industry's capacity to absorb and diversify 
risk.
    2. Intervention should be temporary, permitting us to review in the 
future the ability of the insurance industry to price these risks and 
absorb losses.
    3. Private market actors should face appropriate price incentives 
to encourage efforts to minimize the probability of a terrorist event 
and to limit losses should such an event occur.
    4. Private sector uncertainty about liabilities that arise from 
litigation should be reduced.

    Importantly, these principles do not imply an objective of 
providing Government assistance to the property and casualty insurance 
industry; rather, the principles address implementation of the 
objective of mitigating short-run cost increases for insurance. The 
Administration's approach to terrorism risk insurance adheres to each 
of these four principles. In order to see this, please allow me to 
first explain the basic outlines of how this approach would work.
The Administration's Approach
    After reviewing several options and discussing terrorism risk 
insurance with industry lenders, insurance regulators, and academics, 
the Administration developed an approach, one with which we look 
forward to working with Congress. Upon enactment of this legislation, 
if the United States were the victim of a terrorist attack before the 
end of 2002, the Federal Government would pay for 80 percent of the 
first $20 billion of insured losses, and 90 percent of insured losses 
in excess of this amount. The private insurance industry would pay for 
the remaining insured losses.
    In 2003, the industry would be responsible for the first $10 
billion in insured losses, and 50 percent of insured losses between $10 
billion and $20 billion. Above $20 billion, the Federal Government 
would continue to pay 90 percent of all losses.
    In 2004, the third and final year of this program, the industry 
would be responsible for 100 percent of the first $20 billion in 
losses, and 50 percent of insured losses between $20 billion and $40 
billion. Above $40 billion, the Federal Government would continue to 
pay 90 percent of all losses. In the event that total insured losses 
exceed $100 billion in any calendar year, Congress would determine the 
procedures for and source of any such payments.
    In addition to this insurance component, the Administration 
approach would also consolidate all claims arising from a terrorist 
incident in a single Federal forum. In addition, it would prohibit 
claims for punitive damages (other than those directed at the 
perpetrators), and require that noneconomic damages be proportional to 
a defendant's responsibility (for economic losses, ordinary rules of 
joint and several liability would apply).
    This approach is designed to mitigate economic consequences from 
sudden increases in the cost of terrorism insurance over the next year. 
The imposition of a deductible (in the second year) and a subsequent 
increase in the deductible (in the third year) permits the Federal 
Government to recede gradually from the market as the insurance 
industry adapts to measuring and pricing terrorism risk.
Consistency of Approach With Principles
    The approach I outlined is consistent with the Administration 
principles outlined above. This proposal encourages private sector 
capacity building in several ways. First, it is forward-looking. It 
respects the insurance industry's proven ability to develop the 
capacity to price, market, and service products for new types of risks. 
In the past, naysayers deemed reinsurance against the risks of natural 
catastrophes such as hurricanes as beyond the reach of private 
insurance markets. Experience has proven them wrong. By providing a 
temporary bridge of 3 years, a steadily receding Federal presence, and 
an explicit sunset, we will permit the industry to grow into this new 
market.
    Second, the Administration's proposal recognizes that a limitation 
facing the insurance and reinsurance industry is its total capacity to 
absorb risk. For this reason, we provide the economic function of 
limiting its maximum exposure in order to provide a backstop against 
catastrophic losses, which could generate large increases in 
transactions costs for businesses and, ultimately, for consumers.
    Third, because the industry shares in the losses--up to a maximum 
loss--and the share it shoulders rises over time, there will be a 
profit motive for insurance companies--and actuaries and economists--to 
begin now to refine pricing models. As I noted earlier, there are 
economic benefits to the efficient pricing of risks. While no covered 
individual company can control whether terrorists strike, efficient 
pricing can lead every covered company to take actions lessen the 
damage that results from terrorist incidents. After the approach 
sunsets, the industry will have made progress toward efficient pricing 
of risks. At that time, issues of pricing and the industry's capacity 
to absorb losses can be revisited.
    In addition, having the industry participate will control costs 
after any event. If the Government agrees to pick up 100 percent of all 
claims, the insurance industry has no incentive to do careful claims 
adjustments.
    The potential losses facing insurers depend not only upon the 
security and economic environment, but on the legal setting as well. 
That is why the Administration approach would also include certain 
legal procedures designed to manage mass tort cases arising out of 
terrorism incidents. These procedures will bring damage claims closer 
to their economic foundation and reduce the uncertainty about the 
magnitude of potential claims. The consolidation of claims in a single 
Federal forum, for example, helps to ensure that the claims will be 
treated in a consistent manner and eliminates the redundancy costs of 
litigating similar claims in multiple courts. In addition, 
consolidation tends to expedite the claims process, reducing the 
uncertainty about the length of the litigation. Limitations on punitive 
damages (other than those directed at perpetrators or abettors) and 
proportional liability for noneconomic harms (except those caused by 
perpetrators or abettors) reduces the potential for open-ended claims 
that would exhaust the defendants' resources in mass tort cases. Such 
reforms are essential for economically enhancing the efficiency of the 
insurance market by increasing the ability of the insurance industry to 
price and absorb the risks associated with terrorism.
Conclusion
    To conclude, the U.S. economy is very resilient, and, through the 
combined efforts of the Administration and Congress it is possible to 
provide transitional public policy to support the needs of purchasers 
of property and casualty insurance. Thank you again, Mr. Chairman, for 
the opportunity to appear before you today. I am happy to answer your 
questions.
                               ----------
                 PREPARED STATEMENT OF KENNETH A. FROOT
       Andre R. Jakurski Professor of Finance, Harvard University
                            October 24, 2001
    Mr. Chairman, Senator Graham, and Members of the Committee, I 
appreciate the chance to appear before you today to discuss the 
insurance and reinsurance markets in the aftermath of the tragic events 
of September 11. We run the risk of considerable short-term dislocation 
in these markets going forward, given especially the annual nature of 
reinsurance renewals. At the same time, we need to preserve the 
benefits of a vibrant insurance marketplace: the high-quality 
evaluation, pricing, allocation, and mitigation of risk. So the issue 
before the Committee is extremely important as well as timely.
Some Useful Background
    This is not the first important upset in insurance and reinsurance 
markets. In the mid-1980's, as the U.S. courts entered new territory, 
large insurer and reinsurer exposure to product and environmental 
liability became apparent. Insurance prices rose rapidly. Some firms 
failed, and insurance and reinsurance capital was stressed by the 
additional liabilities. The industry responded by developing 
specialized contracts, and treaties to cover these liabilities. They 
developed schemes for pricing that, especially in the early years, 
proved remunerative. Major financial intermediaries came together to 
sponsor the creation of new major reinsurers to write new liability 
coverage.
    In the early 1990's, the United States experienced two very large 
natural disasters, Hurricane Andrew and the Northridge Earthquake. The 
losses from these events (currently estimated at approximately $20 
billion and $17 billion, respectively) were a shock to an industry that 
rarely considered, and have never before seen, such losses from natural 
perils. Once again, some firms were bankrupted and risk capital was 
stressed.
    Let me trace out the industry response. First, as one might expect, 
insurance and reinsurance prices rose spectacularly immediately after 
Andrew, doubling between 1992 and 1993. Figure 4b shows an index of 
Rate on Line (ROL), the ratio of premiums to policy limits, for 
catastrophe reinsurance. ROL rose strongly in 1993. However, ROL 
actually understates the change in the cost of reinsurance. When the 
price of reinsurance goes up, buyers tend to purchase less, 
specifically by using higher deductibles. The expected claim against 
the policy goes down relative to the limit, thus making the protection 
more expensive than ROL makes apparent. The line labeled ``price'' 
adjusts for this effect. Price is the ratio of the premium paid to the 
expected loss. This is a much truer index of reinsurance cost. The 
event impact on price is considerably greater using this measure of 
price.
    Second, after these very large post-event increases, prices fell 
steadily between 1994 and 1999. The effect of Andrew and Northridge 
dissipated. By 2000 prices were at half of their earlier values. Why 
did this occur? Additional risk-bearing capital and new firms entered 
the reinsurance industry, increasing competitiveness. Approximately $10 
billion of additional capital flowed into these reinsurers, much of 
which is a result of the attractive post-event prices.
    Third, this growth occurred through the creation of a variety of 
new institutional reinsurance mechanisms. For example, the basic 
prototypes for reinsurers domiciled in tax- and regulation-favorable 
countries--Bermuda in particular--were developed and streamlined. These 
tax and regulatory advantages benefit the U.S. insurance industry by 
providing more competitive reinsurance products.
    Fourth, during this same period, additional sources of capital 
outside of the reinsurance sector became active. ``Cat'' bonds and 
related financial instruments, which could be purchased by investors, 
became viable alternatives to reinsurance treaties as a way of 
transferring risk. Even though relatively few ``cat'' bonds have been 
issued, they have promoted competition in the industry. Over the past 3 
or 4 years there have been a number of episodes where major reinsurers 
have succeeded in undercutting the price of ``cat'' bonds. While it is 
unclear whether the motives have been tactical or predatory, what is 
clear is that competition has been enhanced.
    Fifth, while hard to summarize in numbers, the entire discourse 
surrounding natural catastrophe events changed during this post-event 
period. Third-party firms specializing in building objective models of 
potential natural disaster losses grew and, unlike before, became 
popular with insurers, reinsurers, investors, and intermediaries. 
Critics of the objective models engaged them. Conferences and 
specialist groups began to discuss catastrophe risk both qualitatively 
and quantitatively. Insurers, reinsurers, commissioners, regulators, 
rating agencies, and even the general public became far more aware of 
the possibilities of these events, where they might occur, what kinds 
of buildings are at risk, how construction techniques can be improved, 
how damage can be contained, etc. Insurance and reinsurance prices 
increasingly impounded this information. The increase in awareness and 
planning has resulted in significant risk mitigation, better decisions 
about risk exposure and financial capital, and corporate, financial, 
and household sectors that are more stable.
    These changes have helped reduce the post-event price of 
reinsurance. But, perhaps more importantly, they have increased the 
amount of reinsurance protection that is commonly purchased today. To 
see this, Figure 4d shows the reinsurance buying patterns of insurers 
who purchase reinsurance. Specifically, it shows the fraction of 
reinsurer losses covered at different levels of industry losses (in 
2000 dollars). Because this chart covers only insurers who purchase 
protection, it is not representative of the entire insurance industry. 
Nevertheless, it is representative of the level of industry losses for 
which protection is purchased. And the results are striking. Before 
Andrew and Northridge, the most common layer of protection helped 
protect against events generating industry-wide losses of about $4 
billion. As of 2000, the most popular level of loss protection had 
about tripled, to about $12 billion. In addition, today substantial 
coverage has been extended to much larger events. Protection against 
natural catastrophe losses of $20-$25 billion and more is not uncommon. 
This is the legacy of Andrew and Northridge, and it is a permanent one, 
given the changes discussed above.
Some Implications for Today
    This brief retrospective provides context for policymaking in the 
aftermath of the latest, largest ever losses from September 11. First, 
it is clear that reinsurance industry is efficient over the medium 
term. The industry can and does respond to large disasters. High prices 
occur, but these motivate the response. Figure 4b shows that prices 
have fully returned to their pre-Andrew levels, even as Figure 4d shows 
that demand today for reinsurance has increased enormously. This is the 
sign of an economically efficient industry: financial innovation and 
capacity expansion have accommodated a large increase in demand with 
virtually no increase in price.
    Second, there is evidence that the ``medium term'' has today grown 
shorter. Following Andrew, the post-event spike in prices took several 
years to undo. With the losses of September 11 following so closely 
thereafter, there are a number of reasons to believe that the response 
will be considerably quicker going forward.

 Bermudan reinsurers, transformers, and other financial 
    institutional forms including capital-markets instruments can 
    rapidly and smoothly impound new capital. A variety of vehicles 
    allow investors to participate in the reinsurance function through 
    equity in new or existing reinsurance companies, closed-end mutual 
    funds, convertible close-end funds, bonds, convertible bonds, etc.
 In addition to the ``hardware''--meaning explicit 
    organizational forms, contractual and financial instruments--for 
    transferring risk, much ``software'' has also been built. This 
    includes the expertise and knowledge of brokers, investment 
    bankers, reinsurers, insurers, rating agencies, investors, and 
    regulators, who are much more fluent in the activities of risk 
    transfer in property/casualty lines.
 There is direct evidence that the combination of this 
    ``hardware'' and ``software'' works effectively today. As I write, 
    I am aware of approximately $3.0 billion that has already been 
    newly committed to reinsurance capacity directly as a result of the 
    September 11 events. These additional capital infusions involve the 
    expansion or creation of Marsh Axis Specialty Re, AIG, GE, 
    Renaissance Re, Hartford Financial, QBE, Zenith National, Da Vinci 
    Re. These are committed fund raising efforts, fully in place in 
    less than 6 weeks.

    At the end of the post-Andrew price cycle, prices had returned to 
where they began. However, durable progress had been made. The 
``hardware'' and ``software'' create a kind of infrastructure. As a 
result, the catastrophe marketplace today has become more flexible and 
responsive. The risk associated with natural disasters is better 
mitigated and better spread as a result.
    Third, any form of sustained provision of reinsurance by the 
Government will impede this kind of progress. Many decisions throughout 
the economy need to be made that affect exposure to terrorist actions. 
What types of steel and concrete reinforcements help reduce risk in 
buildings of various heights? What kinds of physical barriers around 
tall buildings, stadiums, public works projects are appropriate? What 
kinds of equipment for checking, opening, or possibly sterilizing mail 
should employees reasonably expect? What kinds of security is it 
appropriate for the travel and other industries to provide their 
employees and customers? Insurance and reinsurance markets help provide 
answers to these questions by evaluating and pricing risk, and 
formulating detailed policy requirements. The result is that risk is 
both mitigated and better spread throughout the economy.
    Fourth, the sheer level of uncertainty about the likelihood of 
terrorist attacks is not itself a reason to replace market functions 
with Government programs. Critics of catastrophe modeling including 
some of the most important reinsurance underwriters--argue that the 
models provide false provision and that the probabilities of natural 
disasters are unknowable. The uncertainty surrounding the potential 
one-time impact of the Year 2000 computer bug was certainly extreme, 
yet this did not stop the creation of private insurance dedicated to 
protecting against Y2K damages. The history of the last 5 years 
strongly suggests that market can and does function even when risk is 
hard to evaluate.
The Administration's Proposal
    I support and applaud the Administration's proposal of a limited, 
temporary Federal intervention in the insurance market. A measured 
response is appropriate at this time to assure continuity in insurance 
markets and support renewed economic growth. I am comfortable with all 
but one of the four key principles articulated by Chairman Hubbard in 
his earlier testimony. The intervention should encourage private market 
incentives to expand capacity as needed and diversify risk. It should 
generate appropriate price incentives to encourage the private sector 
to mitigate the losses and risk of a terrorist event. And it should 
help reduce uncertainty about liabilities that arise from associated 
litigation. In addition, I believe that if these three principles are 
to be satisfied, the short sunset feature of the program is absolutely 
essential.
    In that spirit, I would strengthen the second of the 
Administration's principles, which deals with the sunset feature. In my 
view, it should read, ``The intervention should be absolutely 
temporary, and primarily intended to resolve short-term dislocations in 
the market due to a sudden shift in risk and coverage perceptions.'' 
Given the magnitude of the change in expectations that we have just 
experienced, and the very tight calendar before year-end, I believe 
that an intervention is justified. The risk profile of major firms--
both financial and nonfinancial--would be otherwise unbalanced and a 
deterrent to economic growth.
    Over 2 or 3 years, I believe the market is fully capable of 
evaluating, pricing and designing exposure to large risks. If we 
experience losses beyond what the markets are willing and able to 
tolerate, then Government involvement is, at that point, virtually 
assured. This is, and has been, the case for natural disasters. There, 
private market policies are not open-ended; they extend to losses that 
are only so great. Since the largest events are often unknowable 
beforehand, the sensible approach is to define the intervention ex 
post, based on the then-existing circumstances. The existence of a 
Federal program ex ante is unlikely to forestall Federal actions after 
another event should that program then be considered inadequate. As I 
have argued, the existence of anything more than a targeted, highly 
temporary, Federal program is likely to forestall development of better 
insurance markets and pricing, and better risk allocation and 
mitigation decisions by the private sector.
    Thank you again, Mr. Chairman, for the opportunity to express my 
views.


                PREPARED STATEMENT OF KATHLEEN SEBELIUS
       President, National Association of Insurance Commissioners
             Commissioner of Insurance, The State of Kansas
                            October 24, 2001
Introduction
    My name is Kathleen Sebelius. I am the Commissioner of Insurance 
for the State of Kansas, and this year I am serving as President of the 
National Association of Insurance Commissioners (NAIC). Speaking for 
myself and my fellow insurance commissioners, we appreciate the 
opportunity to testify regarding the potential role of the Federal 
Government in making sure that insurance against acts of terrorism 
remains available to American consumers and businesses.
    Today, I want to make three basic points:

 First, NAIC and its members believe there is presently a need 
    for the Federal Government, working with the State regulatory 
    system, to provide appropriate financial backup to the private 
    insurance market in order to assure that our Nation's economy does 
    not falter due to a lack of insurance coverage for terrorism. 
    Although NAIC has not endorsed a specific proposal for Federal 
    assistance at this time, we have adopted a set of 19 guiding 
    principles that we believe should form the basis of any successful 
    Federal program. A copy of the NAIC's guiding principles is 
    attached at the end of my testimony.
 Second, we believe Federal assistance should be a relatively 
    short-term solution to stabilize the commercial marketplace while 
    it regains the risk assessment and pricing equilibrium needed for 
    private insurers to underwrite terrorism exposures. Thus, any 
    Federal terrorism insurance program should be limited in scope and 
    duration.
 Third, a Federal assistance program should maximize the use of 
    market forces to add efficiency and reduce the risk of losses from 
    terrorism and the potential costs to Federal taxpayers.

The U.S. Insurance System Remains Fundamentally Sound
    Let me start by saying that NAIC believes the insurance industry is 
well-capitalized and financially able to withstand the pressures 
created by the September 11 terrorist attacks, despite losses projected 
to exceed $30 billion. The U.S. insurance industry is a $1 trillion 
business with assets of more than $3 trillion. Preliminary loss 
estimates of $30 billion to $40 billion represent just 3 to 4 percent 
of the premiums written in 2000.
    America's insurance companies have time and again shown their 
ability to respond to huge disasters and successfully recover. Adjusted 
for inflation, Hurricane Andrew in 1992 caused $19.7 billion in insured 
losses, and California's Northridge Earthquake in 1994 cost $16.3 
billion in insured losses. As with previous disasters, we believe 
insurers affected by the recent terrorist attacks will be able to pay 
their projected claims, as they themselves have said.
    Insurance is the sale of a promise to pay claims when losses occur. 
As regulators, my colleagues and I will continue monitoring the process 
to make sure that insurance promises are kept. To do our job, we are 
backed by an impressive array of human and technical resources, 
including the NAIC and 51 State insurance departments that collectively 
employ more than 10,400 people and spend $910 million annually on 
insurance supervision. In addition, at this time State insurance 
guaranty funds have the capacity to provide up to $10 billion to 
compensate American consumers in the event of insurer insolvencies.
    We would urge Congress to structure any Federal assistance program 
to take full advantage of the existing State regulatory system. We have 
the mechanisms in place to monitor insurer solvency and handle claims 
payment issues.
Congress Should Not Disrupt the Power of Private Market Competition
    The international commercial property/casualty insurance market is 
very powerful, dynamic, and competitive. As a free market, it responds 
to new information quickly, and sometimes with great volatility. Like 
the stock exchanges, insurance market participants often react in 
unison to reach the same conclusion at the same time with regard to 
what products are viable and profitable, meaning that the price and 
availability of specific products will rise and fall in conjunction 
with the industry's collective willingness to sell them. Substantially 
negative information, such as the September 11 terrorist attacks, can 
disrupt the entire market until new information becomes available that 
makes insuring terrorist risks acceptable.
    Given sufficient time to adjust, however, the commercial insurance 
market has found ways in the past to assess and insure extremely large 
and difficult risks that were initially considered uninsurable. During 
the 1980's and 1990's, the insurance industry weathered enormous 
financial losses from asbestos, medical malpractice, and environmental 
pollution claims against corporate policyholders that were not foreseen 
by insurers. In those instances, insurers said they had not reasonably 
expected to be held responsible for such colossal claims, and therefore 
had not collected sufficient premiums or established sufficient loss 
reserves to cover them.
    In the short term, the insurance market responded to huge 
environmental exposures with policy cancellations, coverage 
limitations, exclusions, and increased prices, as is being threatened 
now with regard to terrorism risk coverage. In the longer term, 
coverage for these risks became available through a combination of 
aggressive risk management, self-insurance, captive insurance pools, 
other alternative risk-sharing mechanisms, and renewed interest by 
commercial insurers as they gained confidence in their abilities to 
adapt their policies and pricing to a level where they could underwrite 
the business profitably. Ultimately, the creativity and competitive 
discipline of the market overcame its initial period of contraction and 
volatility to provide viable insurance solutions for enormous risks 
that were previously considered uninsurable.
    The business of insurance is about measuring risks and selling 
promises to cover them at a reasonable profit. Insurance experts who 
perform these tasks are exceptionally talented. Over time, they have 
demonstrated a remarkable ability to adapt to unforeseen circumstances, 
while making available the insurance products that are essential to the 
growth and productivity of American business. As expected in a free 
competitive market, individual companies may stumble, falter, and even 
fail when substantial adversity strikes, but the U.S. insurance 
industry as a whole has a long and proud record of finding ways to 
overcome new obstacles while advancing its business goals and serving 
the interests of the insurance-buying public.
    Thus, the NAIC believes Congress should begin its consideration of 
Federal assistance to the insurance industry by recognizing the 
strength and adaptability of the private insurance markets. Federal 
actions that unduly disrupt or interfere with private market forces are 
likely to end up causing more harm than good for American consumers and 
Federal taxpayers.
Appropriate Government Action Can Help the Private Market Recover
    State regulators know from their own experiences that Government 
action can help the insurance market recover when it becomes 
overwhelmed by changing risk factors or catastrophic losses. When the 
psychology of the market results in industry reactions that harm the 
public, Government has unique powers to alter the insurance marketplace 
for the benefit of consumers. We have found that successful Government 
assistance involves tailoring actions to fix specific problems and 
keeping the program as narrow as possible.
    Hurricane Andrew provides a useful example of limited Government 
intervention that works. Following the tremendous losses from this 
hurricane in 1992, commercial reinsurers restricted their coverage for 
windstorms and raised prices. This caused a corresponding reaction from 
primary insurers, who moved to raise prices, cancel coverage for 
coastal properties, and increase deductible amounts for consumers 
having significant hurricane exposure. Within a couple of years, 
normalcy returned to the reinsurance market, and then to the primary 
market. The Florida Insurance Department assisted with the recovery of 
the industry by introducing a moratorium on policy cancellations and 
beginning the discussion of the need for a State catastrophe pool. The 
Florida legislature later adopted a Hurricane Catastrophe Insurance 
Pool that provides a State-based backstop for catastrophic windstorms 
in Florida. These collective actions have resulted in a robust and 
competitive market for homeowners insurance in the State of Florida.
    State insurance regulators believe the current situation affecting 
the availability of insurance for acts of terrorism is similar in 
nature to other catastrophic events. Due to the magnitude and 
unpredictable nature of terrorism as it is currently perceived by 
insurers, a temporary level of Federal assistance to spread risk 
appropriately should provide time for the marketplace to adjust its 
thinking about how insurance coverage for terrorist acts should be 
handled. If the Federal Government and business customers make quick 
progress in lessening exposure from acts of terrorism, the insurance 
industry may start providing the coverage American businesses and 
families demand. Enacting a temporary Federal solution will provide the 
necessary time to craft a more thoughtful long-term solution.
Three Important Market Factors for Congress to Keep in Mind
    As Congress considers what type of Federal assistance may be 
appropriate to steady the commercial market while it adjusts to new 
demands, the NAIC recommends that you keep in mind three very important 
factors. These factors will greatly affect the costs of any Federal 
program, as well as its lasting impact on America's consumers and 
private insurance markets.
    First, risk management precautions that reduce the likelihood of 
losses from terrorist attacks will have a large impact on the 
willingness of private insurers to offer terrorism insurance coverage 
to customers. Risk management--the implementation of safety and 
security measures to prevent harm--is a standard part of insuring 
commercial and Government facilities that are most susceptible to 
terrorist attacks. Large firms have professional risk management 
departments whose mission is to reduce a company's exposure to 
potential accidents and intentional harm, thereby improving the 
company's chances to get insurance at the lowest rates possible.
    Following the September 11 attacks, Government and commercial 
facilities across America have added security measures to prevent acts 
of terrorism and limit potential damages. As commercial risk managers 
review these new precautions, it seems likely they will become more 
inclined to offer terrorism insurance because the possibility and 
extent of potential insured losses occurring will be greatly reduced. 
At that point, we expect market forces will start working to fill the 
gap by making terrorism insurance available through private industry.
    The NAIC recommends that Congress build-in strong incentives for 
insurers or companies receiving Federal assistance to implement and 
maintain effective risk management measures to prevent acts of 
terrorism from occurring. In that way, the Federal Government will be 
building upon standard risk-reducing steps that are well accepted in 
the private marketplace for insurance products.
    Second, the private market instills policyholder discipline to 
avoid insurance claims through the concept of co-insurance. Co-
insurance means that policyholders are liable to pay part of any losses 
covered by insurance before expecting a recovery from an insurer. 
Obviously, the higher the dollar amount covered by the policyholder 
himself, the greater will be his incentive to take steps to avoid 
losses. This concept is commonly understood by everyone owning a car or 
a home who agrees to bear the cost of a ``deductible'' before receiving 
payment from an insurance company. Co-insurance should be considered by 
Congress as an important market discipline tool that works equally well 
with Government programs.
    Third, the scope and duration of any Federal assistance program 
will itself become a factor in the private insurance market. Even 
though Congress is considering special Government assistance intended 
to operate as a supplement to normal business channels, the very fact 
that Government will pay certain costs of a commercial business becomes 
a factor to be taken into account when private market decisions on 
terrorism insurance are made.
    The NAIC urges you to keep in mind that Federal Government policy 
regarding terrorism insurance assistance will not occur in a vacuum. It 
will become a private market consideration affecting prices and 
availability of insurance, and it may impact insurance products having 
nothing to do with terrorism. The extent of the Federal influence on 
private market insurance products can be expected to be directly 
commensurate with the size, details, and length of the Federal 
assistance program.
State Actions Are Not Driving the Market Demand for
Terrorism Insurance
    The NAIC and its members have recently been asked to explain how 
requirements of State law impact the market demand for terrorism 
insurance. Many people in Congress apparently think that States require 
private businesses to carry insurance against terrorism, and that 
failure of the private insurance market to offer terrorism coverage 
will result in violating State laws and regulations. We believe there 
is a misunderstanding of what State laws require and what State 
insurance regulators actually do.
    Let me say that States do not drive the private market for 
terrorism insurance. To our knowledge, no State currently requires that 
business entities maintain insurance against acts of terrorism. In 
fact, the NAIC recently performed an electronic search of State laws 
and regulation for references to ``terrorism.'' We found nothing.
    Furthermore, it is important to understand that State insurance 
regulators do not normally get involved in the details of property/
casualty insurance policies for large business operations. These are 
considered to be the product of free market negotiations among 
sophisticated insurance underwriters, brokers, and professional 
corporate risk managers who rely upon the traditional powers of buyers 
and sellers to bargain for the best deal they can get. The State 
regulatory interest in such large transactions is mainly that they not 
impair the overall financial health of an insurer, since monitoring 
insurer solvency is a major responsibility of regulators.
    Banks and investors typically use their private market influence to 
require that large business and Government entities maintain adequate 
property/casualty insurance coverage against foreseeable harm. As a 
result of September 11, foreseeable harm may now start to include 
possible terrorist acts in addition to normal hazards. However, 
terrorism coverage would usually be just one part of a comprehensive 
insurance package that insurers want to sell. Their desire to avoid 
terrorist risk exposures may be offset by their need to include it in 
order to sell a package of insurance coverage judged to be profitable 
overall.
State Actions Having a Limited and Indirect Impact on
Terrorism Insurance
    What, then, is the impact of State laws on terrorism insurance? 
Primarily, it falls into three areas--workers' compensation 
requirements, policy form regulations, and rate regulations. We believe 
these areas have a limited and indirect effect upon the price and 
availability of terrorism coverage in commercial property/casualty 
policies for large business projects that significantly affect the 
American economy. It is important to recognize that States are not 
initiating market requirements in these areas, but only reacting to 
market forces that threaten to deny consumers fair insurance coverage.
Workers' Compensation Requirements
    State workers' compensation laws were developed early in the 20th 
Century. In the late 1800's and early 1900's, the number of 
occupational injuries and illnesses occurring in the American workplace 
was hindering the Industrial Revolution. Businesses were asking how 
they could assure that working men and women who are injured on the job 
get the care they need, while protecting industry and commerce from the 
financially crippling and demoralizing prospect of employees suing 
their bosses for every work-related injury. The question was answered 
with the State Workers' Compensation System, which covers employees' 
medical expenses and lost wages for work-related injuries and disease, 
regardless of who was at fault. In return, employees are limited to the 
benefits provided by the workers' compensation system as their 
exclusive remedy.
    State workers' compensation laws require a set of benefits that are 
guaranteed by employers to their employees who are injured on the job. 
Insurers play a key role in the delivery of the benefits promised by 
employers. Typically, insurers assume by contract the obligation to 
provide the employer's share of medical benefits, rehabilitation 
benefits, and survivor's benefits in exchange for premiums the employer 
pays the insurer. Since State law obligates the employer--and therefore 
the insurer that has assumed the employer's obligations--to provide the 
benefits specified in a State's Workers' Compensation Act, the insurer 
cannot introduce either an exclusion for war or an exclusion for 
terrorist acts.
    As a no-fault safety net for workers' injuries on the job, State 
workers' compensation laws do not permit coverage exclusions as a 
matter of public policy. Workers' compensation insurance is one part of 
the commercial coverage maintained by significant employers.
State Policy Form Regulations
    Many States have statutory authority over insurance contract 
language through general policy form regulations. These requirements 
typically prohibit contract language that is misleading, illusory, 
inconsistent, ambiguous, deceptive, or contrary to public policy. Since 
no currently enacted State laws specifically prohibit an insurer's 
request to exclude coverage for terrorist acts, States would have to 
rely upon the general provisions above if they seek to deny an 
insurer's request to exclude terrorism coverage. Under State law, an 
adverse regulatory decision can be challenged by an insurer through the 
State insurance department's administrative process, with the right of 
appeal to State courts.
    State insurance regulators are also charged with solvency oversight 
of insurers. Thus, an action to deny an exclusion of terrorist 
activities under general policy form provisions could cause financial 
difficulties for insurance companies. However, it is ultimately the 
insurer's choice whether to provide coverage for a specific business 
event or peril. Primary insurers may be hesitant to exclude coverage 
for terrorist acts because they know their business and individual 
customers will want assurances the coverage is provided. Reinsurers do 
not directly deal with businesses and families, and therefore do not 
face the same pressures to provide terrorism coverage.
State Rate Regulations
    State rate regulations are primarily focused on protecting small 
businesses and individual policyholders. For commercial lines insurance 
products, only 13 States still require that the insurance department 
exercise prior approval requirement for most rate changes. The 
remaining 38 jurisdictions have some form of competitive rating 
mechanism that allows insurers to file and use rates, or use them even 
before they are filed with insurance regulators. Moreover, in recent 
years insurers have been successful in convincing State legislatures to 
create rate regulation exemptions for large commercial policyholders. 
The NAIC does not believe State rate regulations are preventing 
insurers from charging adequate rates for terrorism insurance.
Conclusion
    The NAIC and State regulators believe the insurance industry 
remains strong, and that it retains tremendous strength to recover from 
the September 11 attacks and adjust its business practices to new 
conditions in the marketplace. State insurance regulators are working 
together to help assure that any glitches which occur do not disrupt 
the process of getting people's lives back in order and America's 
businesses back to work. The NAIC and its members plan to work closely 
with Congress and fellow regulators, as set forth in the Gramm-Leach-
Bliley Act, so that the needs of individual Americans and our Nation's 
economy are met in a timely way.






                 PREPARED STATEMENT OF J. ROBERT HUNTER
         Director of Insurance, Consumer Federation of America
                            October 24, 2001
    Good day Mr. Chairman and Members of the Committee. My name is Bob 
Hunter. I am Director of Insurance for CFA. I previously served as 
Texas Insurance Commissioner and, of particular relevance to today's 
subject, as Federal Insurance Administrator under Presidents Ford and 
Carter.
    I served at FIA between 1971 and 1980. My first task was to assist 
in establishing the Riot Reinsurance Program under the provisions of 
the Urban Property Protection Act. I encourage you to look at the Riot 
Reinsurance Program for guidance in your current important effort for 
reasons I will cover in the next few minutes.
    In the late 1960's, the Nation faced great uncertainty from a form 
of terror from within. There were an awful series of riots in the land. 
If this were not bad enough for the people in the inner cities who were 
at the equivalent of what we now call ``ground zero,'' the reinsurers 
panicked and began to cut off reinsurance protection from the American 
primary insurance market. The primary insurers, without their layoff 
arrangements were poised to pull out of the inner cities. Then lenders 
would have to call mortgages . . . the set up for a true crisis.
    Congress, wisely, stepped in, creating the riot reinsurance 
program. The program adhered to good insurance principles, requiring 
the Government to charge full actuarial rates for the reinsurance and 
making sure that claims were appropriate for payment.
    I was tasked with the job of coming up with actuarially sound rates 
for the Riot Reinsurance Program. This was about as fearful a job as I 
ever faced. There was great uncertainty. But actuarial soundness is not 
defined as precise prices. It relates to procedures such as using the 
best information available, making reasoned judgements and basically 
doing your best. We did that, full well expecting to be too high or too 
low since future events such as riots are hard to predict.
    I met with insurers, actuaries from the actuarial societies and 
other interested parties and came up with prices. Insurers thought they 
were OK since they bought the reinsurance. The taxpayer was protected 
and, indeed, profited from the transaction. Sound insurance principles 
require proper prices and require adequate supervision of the claims 
payment process.
CFA Supports a Federal Reinsurance Program for Terrorism
    CFA supports a sound program of reinsurance for the terrorism risk 
underwritten by the Federal Government.\1\ I attached a list of 
principles CFA developed for Congress to consider when developing the 
program. Foremost among the principles are that the insurance industry 
must be able to purchase affordable reinsurance and that the taxpayer 
be protected.
---------------------------------------------------------------------------
    \1\ This testimony relates to property/casualty insurance. The life 
insurance industry has requested a Commission to study if they need 
backup. CFA believes that a Commission is not needed. The life 
insurance industry should make its case for when they might need help 
and Congress should call hearings to critique that analysis. CFA looks 
forward to participating in that separate process.
---------------------------------------------------------------------------
Interim Terrorism Insurance Proposal
    CFA understands that creation of the permanent plan we espouse 
below might take more time than we have to protect insurers as of 
January 1, 2002, when most reinsurance runs out. We, therefore, suggest 
that an interim, actuarially sound plan be developed.
    Simply, we believe that most insurers could withstand at least 
another event of the magnitude of the September 11 tragedy. So we do 
not think that the interim plan should cover first dollar losses. CFA 
proposes that a retention be used for each insurer of 5 percent of 
surplus, as of December 31, 2001. ``Terrorism'' must be defined for 
this interim plan and should be determined by a Federal official.
    If a terrorist attack occurs and an insurer suffers claims greater 
than the retention amount, the insurer would be eligible for Federal 
low or no interest loans, the term of which would be negotiated up to 
30 years. This would spread the cost over time, an important goal. For 
each insurer, the discounted value of the loan would be limited to an 
additional 5 percent of surplus.
    Amounts of money loaned in excess of the 5 percent of surplus by 
company would be repaid to the U.S. Treasury through a property/
casualty insurance industry-wide loan repayment mechanism. This loan 
repayment would be collected over a number of that years are sufficient 
to minimize the rate impact on consumers (Congress should set the 
maximum surcharge, perhaps at about 2.5 percent per year, until the 
loan is repaid). The surcharge would be collected by the States as a 
piggyback on their State premium tax mechanism and forwarded on to the 
U.S. Treasury. This step is needed in order to make sure that 
individual company balance sheets are not impacted by very large losses 
due to terrorist activity.
    This plan leaves the regulation of insurance fully in State hands. 
The States should be required to assure availability and affordability 
of the terrorism risk, using their usual regulatory methods, including 
pooling by State, if necessary. Further, the States should be asked to 
assure that the plans enhance security through discounts or other 
incentives. Congress could set goals for the States in this effort. 
This requires little, if any, new bureaucracy since much of this work 
is already part of the State insurance department responsibility.
Needed Protections for the Taxpayer
    Any longer term plan should protect consumers and taxpayers in the 
following manner: First, insurance companies should pay full 
actuarially sound rates for any reinsurance protection they enjoy. Any 
plan that requires no premium is not actuarially sound. The insurers 
need a plan to protect their interests--they do not need a hand out. 
Insurers should be loathe to set a precedent where inadequate premiums 
are acceptable when they are paying the premium, if they do not expect 
consumers to press for inadequately priced home, auto, life, and other 
coverages. When the insurers offer free insurance to us, we will 
consider free reinsurance for them.
    Free insurance is particularly galling in Year One of the coverage. 
Do not forget the insurers made contracts with Americans to cover 
terrorism fully. These contracts are being entered into even as we 
speak. So, for a year for policies being written today and for an 
average of about 6 months for policies already in force, there would be 
terrorism coverage even if Congress did nothing. To come in after-the-
fact and give away insurance to the industry, which is a very healthy 
industry \2\ even after September 11, would be foolish.
---------------------------------------------------------------------------
    \2\ At year-end 2000, the property/casualty industry had surplus of 
$321 billion and net premium written of $303 billion. The rule of thumb 
for a very safe industry is a ratio of $1 of surplus for each $2 of net 
premium written. Thus, the industry had ``excess'' surplus of $170 
Billion. ($321-$303/2). So, even if the industry has another WTC event 
they can afford it.
---------------------------------------------------------------------------
    Actuarial soundness is possible. The taxpayer can be assured that, 
over time, the program would, at worst, cost the taxpayer nothing. Here 
is how to do it:

 Congress should require actuarially sound reinsurance 
    premiums. That does not mean precision, it means doing the best you 
    can to set a price you think is based on reason.
 The plan should include assessments against the industry if 
    terrorism reinsurance claims exceed certain dollar thresholds. 
    During the riot reinsurance days, the industry had to agree to a 
    2.5 percent of their total premium assessment provision in the 
    reinsurance contract.
 The plan should have a provision stating that if the taxpayer 
    has paid more into the plan than the premiums and investment of 
    premiums, the premium collection aspects of the plan will stay in 
    effect until the taxpayer is made whole. Just as in the Riot 
    Reinsurance Program, the plan can be self-sustaining over time. 
    Uncertainty will end and the costs shifted to taxpayers during the 
    uncertain times can be recouped as certainty returns.
 The plan should include a wise payout plan that minimizes 
    taxpayer exposure. The second year of the White House proposal is a 
    good start. That should be the first year of the program. The 
    industry can easily afford a first layer of coverage where they are 
    100 percent at risk for tens of billions. I would set it at $35 
    billion \3\ for Year One. The industry could easily afford three 
    such events even today.
---------------------------------------------------------------------------
    \3\ Some have maintained that this is difficult to do since some 
who suffered loss early would be more exposed than those with later 
claims. This is a red herring. What you should do, I think, is to 
allocate the deductible by insurer based on the sorts of risks they 
have and their surplus level. Then a smaller insurer might be paid even 
if a terrorist loss was relatively small but in the locus of the 
exposure that that insurer wrote.
---------------------------------------------------------------------------
 The Federal Government should have a claims audit role to 
    assure that only claims that meet the definition of terrorism and 
    are within the contractual provisions of the reinsurance policy are 
    paid.

    Second, private insurers should not be able to ``cherry-pick'' 
against the taxpayer. By ``cherry-picking'' I mean sending bad risks to 
the Federal reinsurance program and keeping good risks for the industry 
accounts. Thus, all primary insurance companies should be required to 
participate in the reinsurance program. At the very least, groups of 
insurers should not be allowed to reinsure one company with ``target'' 
risks (for example the Empire State Building) but not reinsure another 
company in the group (say, insuring farm risks).
State Consumer Protections Should NOT Be Impacted by Any
Reinsurance Plan
    One of the beauties of reinsurance by the Federal Government is 
that it is simply a contractual arrangement with the insurer, it does 
nothing to interfere with the carefully constructed system of State 
regulation in place.
There Must Be a Degree of Bureaucracy To Administer the Program
    While it can be minimized, you need staff to develop the contract 
and administer the claims payment process. You cannot just pay claims. 
If you do, the taxpayer will be ripped off. You need a small but not 
insignificant staff (maybe 50) to do this job. The setting of the 
premium charge and the collection of the reinsurance premium requires 
very few staff (maybe 5).
Availability and Affordability of Insurance Must Be Assured
    The reason for Congress to step into this situation with Federal 
backup is to make sure that the economy is not frozen by lack of 
insurance for the terrorism risk. To write a plan that does not do the 
necessary to assure that insurance is written and the price is 
reasonable would be foolish.
    This means that the plan should include a requirement of 
continuation of direct provision of terrorism coverage by insurers as 
part of the ``deal'' for taxpayer backup for those risks that meet 
minimum security standards. Further it means that the rate charged for 
primary insurance should be correlated with the reinsurance charges so 
that there is no gouging by insurance companies at this time of 
national emergency. Congress should not infringe on the ability of 
State regulators to assure that price gouging for primary insurance 
does not occur.
Critique of Industry Proposal
    The Consumer Federation of America strongly opposes the industry 
drafted ``Insurance Stabilization and Availability Act of 2001.'' This 
proposal is a massive overreach that unnecessarily exposes taxpayers to 
billions of dollars in risk. There are several serious problems with 
the industry approach:

 The bill does not require actuarial soundness. Indeed, 
    insurers would pay nothing for reinsurance for the first year of 
    the program, until the mutual insurance company created under the 
    bill builds up a $10 billion net asset base. Apparently, this free 
    Government reinsurance would even cover policies already in force 
    for which insurers are fully at risk today. This is a grossly 
    improper use of taxpayer monies.
 Insurers can ``cherry-pick'' risks since they could opt in or 
    out of the reinsurance program at will. One insurer of a group of 
    companies could be set up to take all of the ``bad'' risks and buy 
    the reinsurance, effectively adversely selecting against the 
    taxpayer. Further, ``cherry-picking'' is allowed in that the 
    insurers can decide whether to reinsure personal risks and 
    commercial risks separately.
 The selection of Illinois as the sole regulator of the new 
    Federally backed mutual insurer puts consumers at risk. Illinois, 
    unlike most other States, does not control prices. Congress should 
    not interfere with normal insurance protections afforded business 
    and personal consumers. If Congress decides to interfere, a Federal 

    agency should be empowered to regulate the insurers, including the 
    rates charged for the reinsured coverages, to assure that no price 
    gouging occurs. (Why enact a terrorism reinsurance program to make 
    insurance affordable and then let insurers charge whatever they 
    want for the coverage?) If one State were to be used to regulate 
    the rates and policies offered (something CFA does not favor), the 
    most advantageous for consumers would be the largest State, 
    California. Studies show that California insurance oversight has 
    been the best in the country over the last decade.
 The bill would cover war events only for workers' 
    compensation. The bill should cover war for all lines of insurance 
    and the reinsurance program should be so constructed.
 The bill waives the application of all Federal and State 
    antitrust laws. This is unnecessary and inappropriate.
 The bill allows territorial differences in pricing, which 
    means that New York City will likely pay much higher rates than 
    other cities, particularly if there is no Government review of 
    insurer pricing decisions, as the bill proposes.
 There is no guarantee of affordability or availability of 
    coverage to reasonably secure risks.

    We urge you to reject the insurance industry proposal and, instead, 
use the very successful Urban Property Protection Act of 1969 as the 
precedent for this program, as reflected in the principles developed by 
CFA (printed below).
Critique of the White House Proposal
    The White House proposal is flawed for several reasons. First, it 
is actuarially unsound. The taxpayer should not give away reinsurance.
    Second, the first year payout plan shows a fundamental 
misunderstanding of insurance. The 80/20 percent split starting at the 
first dollar of terrorism loss will actually leave the taxpayer exposed 
to 100 percent of the risk. This is because the plan will reinsure the 
reinsurers. So, the primary insurers will reinsure the 20 percent the 
taxpayer is not on the hook for with the reinsurers. The reinsurers 
will then ``buy'' (for no premium) the 80/20 percent cover. This will 
increase the taxpayer share to 96 percent (100 percent-[20 percent*20 
percent]). But that is not the end of the reinsurance process. The 
reinsurers will again reinsure (called ``retrocession'') with other 
reinsurers (possibly including the primary carriers themselves). The 
taxpayer share will then go to 99.2 percent (100 percent-[20 percent*20 
percent*20 percent]). If they reinsure again (there is no limit on how 
many times the risk can be ping-ponged to lay off risk on the taxpayer) 
the taxpayer share would be 99.8 percent. And so on. This could be 
corrected by not exposing the taxpayer to private reinsurance payouts.
    A better approach would be to change the plan to have a large 
deductible. As indicated earlier, I think that amount should be $35 
billion. Over that, there should be sharing as in Year Two of the White 
House plan . . . but no reinsurance should be allowed on private 
reinsurance claims even in that scenario. The White House plan also 
does not guarantee affordability or availability of coverage to 
reasonably secure risks.
Conclusion
    Congress can and should backup the private insurance market with 
reinsurance for the peril of terrorism. It can and should do it in a 
wise way that protects the taxpayer and, over time, assures that the 
taxpayer is reimbursed for the costs of the program so that the cost 
goes to ratepayers rather than to taxpayers.
    CFA looks forward to working with the Congress on this most 
important effort.
                    Guiding Principles for Insurance
                Legislation Related to War and Terrorism
    1. CFA supports the concept of Federal backup of the private 
insurance industry for the perils of war and terrorism. We suggest the 
riot reinsurance program as a precedent for this backup.
    2. Legislation should supplement but not replace other private and 
public insurance mechanisms where those mechanisms can provide coverage 
more efficiently. However, all insurers should be required to reinsure 
against the perils of war and terrorism through the Federal Government 
at the outset of the program. In time, as conditions warrant, private 
reinsurance should be encouraged. To avoid undue taxpayer exposure, 
however, the program should include a requirement of minimum extended 
terms for reinsured insurers with claims paid to allow taxpayers to 
recoup some of the losses.
    3. There should be a reasonable coordination and structuring of 
State and Federal regulatory responsibilities with respect to a Federal 
terrorism reinsurance program that achieves the objectives of the 
program without unnecessarily compromising or preempting State 
regulatory authority and consumer protections. Necessary preemption of 
or limits on State regulatory authority should be compensated by 
requisite Federal oversight.
    4. There should be an appropriate balance of different private and 
public interests in the governance of regulatory oversight over the 
program. Consumers (business and personal), insurers, reinsurers, and 
State regulators of insurance should be on the board of advisers for 
such program.
    5. All records relating to the program, including the records of 
the reinsured insurance companies should be available for Federal audit 
and, to the maximum extent possible, made public.
    6. Rates for the war and terrorism perils charged for the 
Government reinsurance should be actuarially sound and should consider 
all reasonable factors that can be feasibly measured and supported by 
theoretical and empirical analysis.
    7. The Federal Government should assure that the cost of terrorism/
war coverage charged by reinsured insurance companies to the consumer 
is actuarially based and correlated in price with the reinsurance 
offered by the Government.
    8. The legislation must clearly define ``terrorism'' and ``war'' 
and exclude any coverage beyond those definitions. A top Federal 
official should determine if a specific event falls into either of 
those definitions.
    9. Anti ``cherry-picking'' provisions such as the following should 
be included: Legislation should recognize that many war or terrorism 
exposures subject the Government to potential adverse selection as 
insurers with less catastrophe risk are less likely to voluntarily 
purchase coverage, while those with greater risk are more likely to 
purchase coverage. If legislation were to create a Government 
reinsurance program, the program should encourage the inclusion of both 
low-risk and high-risk insureds to promote greater risk spreading in a 
way that does not subject the Government to adverse selection.
    10. Legislation should promote or encourage coverage that is 
available to any property that meets reasonable standards of 
insurability. Federal security requirements should be met within 
reasonable time periods by insured risks and policed by inspection by 
reinsured insurers.
    11. State residual market mechanisms and other pooling mechanisms 
for insurance should be allowed to participate in the entity 
established by legislation to 
provide war and terrorism insurance, in such a way as to not create 
incentives for business to be placed in the residual market. To the 
extent that a risk meets the minimum security requirements, it should 
be able to get war and terrorism coverage through some source . . . a 
residual market if necessary.
    12. Jurisdiction over claim settlement practices should remain with 
the States.
    13. Tax law changes should be encouraged to avoid penalties on and 
encourage the accumulation of reserves for war and terrorism losses.
    14. Legislation should encourage loss reduction and hazard 
mitigation efforts through enhanced security.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



                        TERRORISM RISK INSURANCE

                              ----------                              


                       THURSDAY, OCTOBER 25, 2001

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.

    The Committee met at 10 a.m. in room SC-5 of the Capitol 
Building, Senator Paul S. Sarbanes (Chairman of the Committee) 
presiding.

         OPENING STATEMENT OF CHAIRMAN PAUL S. SARBANES

    Chairman Sarbanes. If the witnesses will take their seats, 
we can get the hearing underway. Mr. Baker, I understand you 
have a time constraint so why don't we move you up from the 
second panel to this panel, and that will give us an 
opportunity to hear from you. By what time do you have to 
leave?
    Mr. Baker. Around noon.
    Chairman Sarbanes. Oh, well, we are in good shape here. I 
might even have kept you on the second panel.
    [Laughter.]
    But we will not want to take that chance. Today we continue 
our consideration of the question of terrorism insurance in 
light of the attacks of September 11. We began our examination 
of this issue on yesterday, both morning and afternoon as you 
are probably aware, and we had a very informative hearing and 
the opportunity to explore a variety of views, including 
hearing from the Administration and in particular Secretary 
O'Neill.
    I believe we gained a number of valuable insights as the 
Committee seeks to deal with this issue. And, of course, we 
have been exploring the extent to which the events of September 
11 threaten the availability of terrorism coverage for 
commercial property owners. If such coverage should be 
unavailable, what impact that would have on the functioning of 
the economy. And, is Federal intervention necessary to prevent 
any such disruption? If so, what form should that intervention 
take? We are increasingly focusing on the last question there, 
but we would appreciate the witnesses helping to build a record 
by walking us through the other issues as well.
    We have been looking forward to hearing from this panel. I 
want to assure the witnesses at the table that we are here to 
hear you with a very open mind, so this headline here in the 
Financial Times ought not to set you back or dissuade you, 
which says, ``Industry plan to aid insurance groups labeled 
nonstarter.'' That was not a statement by me, and I do not 
think--we have a more open mind than that. So we are happy to 
hear any plan that you might want to put forth.
    We will have two panels this morning. The first panel will 
include Robert Vagley, President of the American Insurance 
Association; Ron Ferguson, CEO of General Re Corporation, 
representing the Reinsurance Association of America; and John 
Sinnott, CEO of Marsh, Inc., representing the Council of 
Insurance Agents and Brokers. And they have been joined on this 
panel by Leslie M. Baker, the Chairman of Wachovia.
    The second panel, which will follow immediately after we 
conclude with this one, will include Tom Donohue, President and 
CEO of the U.S. Chamber of Commerce; Tom O'Brien, Chief 
Financial Officer of LCOR, who is representing the Real Estate 
Roundtable; and Walter Knorr, Chief Financial Officer of the 
City of Chicago.
    I just want to take a moment before we go into this panel 
to express my very deep appreciation to my colleagues on the 
Committee and even more so to the Committee staff on both 
sides, Members' staff, for the extraordinary work that has been 
done with respect to the Committee's agenda over the last few 
weeks.
    This afternoon we are scheduled to vote on and presumably--
not only presumably, but certainly pass the antiterrorism 
legislation which will contain within it a title on money 
laundering, which was the work product of this Committee and 
our colleagues over on the House side. And that represented an 
incredible concentrated effort on the part of the staff working 
through the night on a number of occasions over a 2 week period 
in order to complete that legislation and resolve the 
differences with the House and move it forward. We think that 
is an important piece in the fight against terrorism.
    We believe it is carefully worked out and considered 
legislation. We sought to consult with all interested parties. 
All interested parties did not get exactly what they wanted. 
That is never possible. But we do think it will provide an 
effective framework for our authorities to crack down on money 
laundering and do it in a way in which the banking industry 
will be able to work in a cooperative fashion. They will have 
to assume some additional burdens, but the whole country is 
assuming additional burdens at this point. And so I want to 
thank the staff for this terrific work.
    And we have also, of course, tried to move ahead on the 
issue that we are considering this morning. Hearings are now 
being held elsewhere on the Hill as well. But, of course, we 
launched these hearings yesterday. We are carrying them on 
today. We seek to distill out of all of what we are hearing 
hopefully a consensus position. We need to work out something 
that commands the general support or at least acceptance if we 
are to move forward on this issue in the time period that is 
remaining.
    Having said that, Mr. Baker, why don't we go with you 
first? We are really moving you up.
    [Laughter.]
    Chairman Sarbanes. We moved from your panel, and now we are 
going to move you to the front of this panel. And we would be 
happy to hear from you, sir, and then we will go to Mr. Vagley. 
Am I pronouncing it correctly?
    Mr. Vagley. Right.
    Chairman Sarbanes. We would be happy to hear from you, Mr 
Baker.

            STATEMENT OF LESLIE M. (BUD) BAKER, JR.

                 CHAIRMAN, WACHOVIA CORPORATION

                          REPRESENTING

               THE FINANCIAL SERVICES ROUNDTABLE

    Mr. Baker. Mr. Chairman and Members of the Committee, thank 
you for the opportunity to testify on a critical matter. My 
name is Bud Baker, Chairman of Wachovia, here on behalf of the 
Financial Services Roundtable.
    I am also here today to tell you that without cooperation 
between our Government and America's private industry in 
support of insurance activities, there could be major 
disruption in the marketplace and potential harm to the 
economy.
    On October 10, thirty chief executive officers from 
Roundtable member companies signed a letter to the Congress 
expressing concern over the impending lack of terrorism 
coverage and urging Congress to act this year. It is important 
to note that 22 of those 30 signatories are bankers, including 
Wachovia.
    The President of the United States, the Chairman of the 
Federal Reserve, the Secretary of the Treasury, and many 
Members of Congress have recognized that our economy needs an 
economic stimulus package. Without Congressional action to 
provide a Federal backstop for terrorism insurance, efforts to 
provide an economic stimulus could be rendered ineffective. 
This is an issue about the ability of the United States to 
recovery from the terrorist attacks of September 11 and the 
ongoing issues of uncertainty which now weigh upon the economy.
    Without insurance coverage for terrorist acts, it will be 
much more difficult for bankers to extend or renew commercial 
loans or lines of credit for business purposes, construction, 
or development. If the insurance industry cannot offer adequate 
insurance to a borrower or a bank because it cannot properly 
price or reinsure the risk, the bank is faced with a serious 
risk assessment problem. Is it prudent to make a loan to 
construct a pipeline or a power plant, a large shopping center 
or office building when the potential for the borrower to repay 
is diminished by inadequate insurance coverage? For most banks, 
the answer will be ``no.'' In many cases such a loan most 
assuredly would be considered unsound.
    Wachovia is one of the five largest commercial real estate 
lenders in the United States. Our company has total commercial 
exposure of approximately $252 billion, including real estate 
and small business loans. I am particularly concerned about the 
impact on small business customers who are already experiencing 
wide disparity in quoted premiums due to insurers' inability to 
price products consistent with standard actuarial analysis. In 
the case of large or small business, only the Federal 
Government can provide the insurance industry with the 
breathing room it needs to return to a stable, rational market. 
Without a Federal backstop, businesses will have to self-
insure, putting their capital and ours at risk. Magnify that 
potential loss of capital across the domestic banking 
sector to gain an appreciation for the dramatic impact a loss 
of insurance could have on our economy.
    Mr. Chairman, it is impossible to determine if, when or 
where a terrorist might strike. But it is quite clear what the 
business ramifications can be. We are certain, however, that 
the lack of insurance coverage for terrorism will mean fewer 
loans, and that will mean constriction of the economic activity 
across the country. When a loan is not made, the jobs that 
build the plant or run an office cannot be created. With 
appropriate support and assistance from the Federal Government, 
the insurance industry can be in a position to accept the risk 
associated with terrorist attack, and our economy can continue 
its march to recovery.
    The Roundtable is familiar with the various proposals that 
have been developed. We have deliberately not stated a 
preference for any particular one. From my perspective, any 
proposal must pass a simple test: It must return predictability 
to the market. I am certain that given the close collaboration 
between the Congress, the Administration, and the industries 
affected, we can work together to develop a fine solution.
    Thank you very much, Mr. Chairman. I would be pleased to 
answer any questions.
    Chairman Sarbanes. Thank you very much.
    Mr. Vagley.

                 STATEMENT OF ROBERT E. VAGLEY

           PRESIDENT, AMERICAN INSURANCE ASSOCIATION

    Mr. Vagley. Thank you very much, Mr. Chairman. My name is 
Robert Vagley and I am President of the American Insurance 
Association, a leading property and casualty trade association 
in the United States. Before beginning my formal remarks, Mr. 
Chairman, I would like to thank you so much for your 
willingness to consider this matter and to thank you and 
Senators Gramm, Dodd, and Schumer for your leadership on this 
issue.
    Mr. Chairman, the tragic events of September 11 forever 
changed our collective understanding of and concern about 
terrorism. We lost many valued business colleagues and dear 
friends in the attacks on the World Trade Center and the 
Pentagon, and no discussion of this subject should proceed 
without a heartfelt remembrance of them. Mr. Chairman, the new 
post-September 11 world is fundamentally different than that 
which existed before, surely for Americans in general, and very 
specifically for property/casualty insurers and our customers.
    Current estimates of total insured losses resulting from 
the September 11 attacks are between $30 billion and $60 
billion, although the final number could end up being higher. 
The September 11 attack is by far the most costly insured event 
in history. The amount of losses from September 11 may well 
exceed the entire U.S. property/casualty industry's net income 
for the past 3 years.
    Notwithstanding the enormity of this loss, the insurance 
industry is committed to meeting our promises to policyholders 
affected by the events of September 11. We are paying claims 
quickly and fully, and have received in excess of $20 billion 
in declared claims to date. We are not seeking any financial 
assistance to meet these obligations.
    Looking ahead, however, we are very concerned about what 
will happen if, heaven forbid, there are additional terrorist 
attacks on our country. The financial capacity of our industry, 
while sizable, is limited and finite. Unfortunately, the 
potential harm the terrorist can inflict is both totally 
unpredictable in frequency and 
almost infinite in severity. These two factors combined make 
terrorism risks uninsurable.
    There is another important aspect to this issue. Over two-
thirds of annual reinsurance contracts are renewed each January 
1. Reinsurers already have notified primary carriers that they 
intend to exclude or dramatically scale back terrorism coverage 
in the reinsurance contracts coming up for renewal. They are 
not to blame for this. These risks are no more insurable for 
them than for us.
    Primary carriers do not have the same flexibility as 
reinsurers with respect to our own products, because we are 
subject to tighter regulatory controls. Any terrorism 
exclusions we might choose to introduce must be approved by 
individual State insurance departments. If approved, our 
customers could find themselves bearing 100 percent of the 
risks associated with terrorism. Certainly the repercussions of 
this are clear. However, if exclusions were denied, the 
insurers would be left to shoulder 100 percent of future 
terrorist losses, which we simply cannot afford to do. Our only 

remaining option, and one we would prefer not to consider, is 
to simply withdraw from certain markets and/or lines of 
coverage.
    So we face a very difficult dilemma. How can we remain 
solvent and still serve the real needs of our customers for 
financial protection against terrorism? We believe that the 
only course of action is enactment of legislation to create a 
Federal financial backstop for losses that result from future 
terrorist attacks. This backstop could be temporary, but must 
be enacted before Congress recesses in order to avert the 
market crisis that will occur on January 1.
    This is not--repeat, not--a bailout for the insurance 
industry. In fact, the primary beneficiaries of such 
legislation would be our customers and the U.S. economy. The 
purpose of the legislation would be to ensure that adequate 
insurance coverage remains available to American businesses. 
There are a few ways in which this can be done. One is the 
British-style reinsurance pool concept which we have advanced. 
Another is the quota share approach recently offered by the 
Administration. A third could involve some industrywide 
deductible or retention. We are not wedded to the details of 
any particular proposal, not even our own, though we do believe 
it offers the best hope for restoring this market. However, in 
order for any legislative plan to be successful in averting the 
looming economic crisis, it must be drafted in a way that 
improves predictability, stabilizes the market, and preserves 
insurer solvency.
    We understand that in all likelihood, any new risk-sharing 
mechanism for terrorism coverage will include some significant 
retention of future losses by private insurers. On that point, 
I would like to note that the more risk insurers are forced to 
retain, the less stability there will be in the marketplace, 
and the higher the retention, the higher premiums will have to 
be.
    Mr. Chairman, terrorism has become uninsurable in the 
private marketplace as currently structured. Appreciating that 
an immediate stopgap solution may be somewhat imperfect, we 
expect that dislocations will still occur as insurers may 
cautiously reenter the marketplace. It is our hope that with 
time and experience, we will be able to craft longer-term, more 
complete solutions that avoid such disruptions.
    In the absence of Federal legislation to prevent the 
complete collapse of the commercial insurance market, entire 
sectors of the U.S. economy could be left wholly exposed and 
unable to continue the normal course of business. I urge you to 
act quickly and decisively to ensure that all businesses are 
able to obtain much needed protection against future losses.
    Thank you for your attention.
    Chairman Sarbanes. Thank you very much, sir. Before I turn 
to Mr. Ferguson, what percent of the property and casualty 
insurance companies belong to the AIA?
    Mr. Vagley. Of the affected losses, probably about 70 
percent of the affected companies.
    Chairman Sarbanes. And just as a general picture, the total 

coverage?
    Mr. Vagley. The total coverage, including personal lines 
and lines that are unaffected, probably about 35 percent.
    Chairman Sarbanes. Okay. Mr. Ferguson, we will be happy to 
hear from you.

                STATEMENT OF RONALD E. FERGUSON

                CHAIRMAN, GENERAL RE CORPORATION

                          REPRESENTING

             THE REINSURANCE ASSOCIATION OF AMERICA

    Mr. Ferguson. Thank you. Mr. Chairman, Senator Gramm, good 
morning. I am Ron Ferguson. I am one of the 2,400,000 people 
that work in the insurance business in the United States. I am 
proud of our industry. I am proud of the role we play in our 
society and our economy.
    As you well know, the insurance business was front and 
center in the tragedy of September 11 in terms of claim 
dollars, which we will talk about, but also in terms of lives 
lost. We will individually and collectively as a Nation recover 
from this and move forward. We will get back on our feet. We 
are all working to do that under the leadership of President 
Bush, Congress, the heroes on the ground and now overseas, we 
are assured of doing that.
    I have five main messages here this morning, Mr. Chairman: 
One, the September 11 claims will be paid. Two, there is a 
crisis brewing right now, today, on the availability of 
terrorist coverage. Three, I believe that in time we will win 
the war on terrorism and we will see a return to a normal 
private sector insurance market for these coverages. Four, we 
do need a transition period that, in my humble opinion, will 
inevitably involve the Federal Government in a backstop role. 
Five, as we go down this path, I believe there are a few 
principles that we need to articulate and follow. If I may, Mr. 
Chairman, I would like to elaborate just a bit on each of those 
five headlines.
    Chairman Sarbanes. Certainly.
    Mr. Ferguson. Thank you. As for the September 11 claims, 
there is no way to measure or dimension the grief, but we can 
tote up the insurance dollars. As Mr. Vagley said, analysts 
indicate that the range of insured losses for all lines, 
including life insurance, is likely to be between $25 billion 
and $40 billion. A lot of guesswork, but that is the best 
guess. My own personal opinion, which should be accorded no 
special weight or credibility, is that we are going to be at 
the high end of that range.
    How will these losses be paid? First, there was never a 
nickel of premium collected for these coverages because no one 
expected them to happen. That is the plain and simple truth. 
Second, there are no assets on insurance company balance sheets 
or reserves that are earmarked for this coverage. Third, there 
are no hidden reserves in the balance sheet of the insurance 
industry. These losses will be paid out of the capital account, 
out of the shareholder, or in case of mutuals, policyholder 
funds.
    Let us talk about those funds for a moment. Broadly 
speaking, the entire insurance industry--life, health, casualty 
and all lines--has policyholder surplus or net worth of about 
$500 billion. The property/casualty industry, which bears the 
great bulk of these claims in this instance, has a policyholder 
surplus of about $300 billion at June 30. But we need to narrow 
the focus and analysis a little more, and we have to talk 
about, as Mr. Vagley did, the affected companies--those 
companies that write the commercial lines business, the 
workers' compensation, the property that indeed generated these 
losses.
    If you then go down from the $300 billion to the affected 
companies and lines of business, I believe that the capital 
account that supports that business is about $125 billion. So 
we quickly have to go from the $500 billion headline down to 
the surplus that is directly supporting these lines of 
business, and that is about $125 billion. Tillinghast, which is 
a very well respected actuarial firm, has actually come up with 
an even lower number than I did, and they estimated it at $80 
to $100 billion capital that is supporting these lines of 
business.
    In any event, numerically, you can certainly make the 
argument, and I am here to do that, that the losses of $25 to 
$40 billion can be funded out of that capital account. But that 
capital account, it must be understood, also supports other 
operating risks, other investment risks. And so now it has been 
reduced or impaired and we have to collectively ask the 
question, ``and then what?'' What happens after this? What if 
there are multiple events?
    All of the normal actuarial pricing and predictive models 
do not hold up here. We have one horrific data point. That is 
all we have to go on. The rational response for individual 
companies, Mr. Chairman, is likely to be that they will either 
restrict the amount of terrorism coverage they write or they 
may not offer it at all in certain cases, or they may try to 
simply underwrite around it and not provide insurance in 
certain targeted areas. And different companies will choose 
different paths, and it is very hard if not impossible for me 
to dimension that for you. But I think absent some backstop and 
plan to go forward, it is inevitable that will happen and it is 
starting to happen today.
    Chairman Sarbanes. Mr. Ferguson, have you ever been at a 
stoplight when it was red and wished you could go on through?
    [Laughter.]
    Mr. Ferguson. Yes. That is the way I feel right now.
    Chairman Sarbanes. Well, I am telling you here we can give 
dispensation. So just ignore that red light.
    Mr. Ferguson. No ticket?
    Chairman Sarbanes. No ticket.
    Senator Gramm. But do not forget it is there.
    [Laughter.]
    Mr. Ferguson. And it can come back at a moment's notice.
    Chairman Sarbanes. Yes. Do not get carried away, but we are 
really very anxious to get the benefit of what you gentlemen 
have to tell us.
    Mr. Ferguson. I will try to move along. I understand. I 
appreciate it. Thank you, sir.
    So we do have an availability crisis in the making. It is 
not just a January 1 problem. It is easy to slip into that 
thinking. It is a today problem. All those policies that were 
out there on September 10 and exposed on September 11 still 
exist today. It could happen again this afternoon.
    Steve Bartlett from the Financial Services Roundtable said 
it in the shortest possible way. He said, ``No insurance, no 
lending; no lending, no economy.'' I could not improve on that 
short statement.
    Chairman Sarbanes. Steve is pretty good.
    [Laughter.]
    Mr. Ferguson. In time we are going to win this war. We are 
going to win the war on terrorism and the markets are going to 
return to normal. They always do. We have the examples of the 
nuclear energy business which in the late 1950's had to set up 
some special pools and a Government backstop. We had the urban 
riots in 1965. But it takes time. It takes time to run these 
transitions. But with a Federal backstop program, it can be 
done. The nuclear risk matter was handled successfully in the 
1950's. The urban riot insurance was handled successfully. And 
today, there is little or no Federal involvement in either of 
those areas, because the private market has come back in.
    Now we have several models in play today, as Mr. Vagley 
said. I am not wedded to any one particular model. I am only 
wedded to the idea of going forward from here. I do have a 
couple of principles I would like to articulate very quickly 
before the red light comes on again.
    Chairman Sarbanes. No, no. Do not worry about that. You 
take your time.
    Mr. Ferguson. You are very kind. I would like to offer a 
few principles that need to be agreed on, I think and followed.
    One, we need to very clearly define the problem and the 
objectives lest we get into objective creep and unintended 
consequences.
    Two, we need to make sure that all the interests--the 
insurance companies, the insureds, the policyholders, the State 
regulators, and the Government--that we have a plan that aligns 
all of those interests. We need a plan that is workable at the 
micro level. What I mean by that is, it is companies and it is 
underwriters and companies that make the decisions every day. 
It is not the industry as a whole. And we need to provide for 
the people at the companies, the underwriters that price this 
risk and make the go/no-go decisions every day have reasonable 
certainty as to what they are signing onto, that they have an 
agreed definition of what terrorism is so we do not end up with 
51 different definitions, 52 counting the Federal Government. 
We need to have consistency there.
    Three, we need some latitude in the ratemaking from the 
traditional rate regulatory system that is applied at the State 
level.
    Four, I believe any plan must allow for current and future 
private sector response. It will come back. It is just a 
question of time.
    Five, any plan--this is the tricky part--it has to be long 
enough to restore the confidence and the predictability Mr. 
Baker was talking about but short enough to avoid being 
institutionalized. And that is the hard part of this.
    My boss is Warren Buffett. And Warren Buffett has a truly 
remarkable way of cutting through complex issues and putting 
them into common sense, everyday words. He did that the other 
day in The New York Times on this issue. He said two things I 
would like to share with you. He said, number one, ``We do not 
want to write coverages. We do not want to make promises as an 
insurance company, as Berkshire Hathaway, unless we are 
absolutely certain we can fulfill those promises. Otherwise, it 
is a cruel hoax.''
    Number two, he said that, ``This is not a bailout of the 
insurance industry, it is a bail-in. Let's find out how we can 
get together and bail-in and find the way forward.'' I wish I 
could turn phrases the way he does. I cannot, so I can only 
quote them. Mr. Chairman, we can do the job, but we need your 
help for now. Thank you for your time and thank you for the 
dispensation on the traffic ticket.
    Chairman Sarbanes. Thank you very much, sir.
    Mr. Sinnott.

                  STATEMENT OF JOHN T. SINNOTT

                 CHAIRMAN AND CEO, MARSH, INC.

                          REPRESENTING

          THE COUNCIL OF INSURANCE AGENTS AND BROKERS

    Mr. Sinnott. Thank you, Mr. Chairman. I would like to 
explain what Marsh, Inc. is because some people cast us as an 
insurance company. We are not. We are the largest risk advisor 
and insurance broker in the world with 35,000 employees with 
offices in about 100 countries around the world.
    We represent and advise clients, the consumers of 
insurance. We represent all aspects of all levels of business 
clients, from the smallest business client up to the Global 
1,000 if you will. We also serve private clients. And finally, 
we also serve as a reinsurance broker and service provider for 
insurance companies.
    So I am speaking today from a different perspective that my 
colleague is. I am speaking from the consumer standpoint, both 
the insurance consumer and the reinsurance consumer, who needs 
the reinsurance. And we have a very good perspective as to what 
the current conditions are in the world today. And we think we 
have a very good perspective as to the immediate future.
    I should also say that I speak today not just representing 
Marsh, Inc., but I also speak as a member firm of the Council 
of Insurance Agents and Brokers. That is our national industry 
association. It represents about 245 of the larger firms which 
comprise somewhere in the neighborhood of 75 to 80 percent of 
the commercial insurance transacted in the United States.
    I will not repeat some of the points already made. However, 
there are really two problems as we see it. First of all is the 
size of the event that took place on September 11. I might 
disagree with Ron. I would say that our best estimates are 
that, yes, it will be at the top end, and maybe even more 
because of the uncertainty that still exists. That is twice as 
large as the next largest catastrophe event that ever occurred, 
more than twice.
    Looked at another way, if we added to Andrew, which was the 
next largest, the next five largest catastrophe claims that 
took place in the last 10 years and we aggregate those 
together, that in my estimation will equal September 11. So we 
have a very significant severity problem.
    Second, the problem is uncertainty. And insurance is an 
important social instrument, and it is used to dealing with 
uncertainty. That is the nature of its business. But if the 
uncertainty gets to such size and the probability of losses 
becomes so large, then it creates a situation where the 
instrument does not respond. And that is what we have today.
    And January 1 is a very key date. But I can tell you that 
right now, working for our clients in putting together their 
insurance programs, some of which renew prior to January 1, we 
are already faced with exclusions for terrorism.
    So what we see here is that the primary insurers will not 
be able to provide our clients with what they need if the 
reinsurers that back them, that provide the spread of risk, 
feel that they cannot underwrite this particular risk. Simply 
stated, without sufficient insurance coverages, businesses and 
other entities will be handcuffed at a time when they are 
already wrestling with a slowdown in the economy.
    My message is fairly simple. When there is a cure for the 
current environment, and that cure will only take place if 
there is a partnership between the Government and the private 
industry, business doing its best to better secure its 
environment, Government working to secure the country's 
environment, I am convinced, we will be back to where what we 
are talking about today will not be needed.
    I will make one final comment. Marsh was in the World Trade 
Center in 1993 when the first terrorist attack took place. 
Fortunately, we did not lose a single employee. And the insured 
loss--because we are also an insurance consumer, and quite a 
large insurance consumer--the insured loss that we collected 
was less than $5 million on our property and business 
interruption.
    On September 11, we lost almost 300 colleagues. I mean, 
that is the real tragedy, and that is what we carry as we walk 
through our office and all my colleagues around the world, that 
is what we are carrying today.
    But in addition, the insured claim that we will have to 
submit to our insurers will not be measured in a few millions, 
it will be measured in the hundreds of millions, and that is 
not the type of exposure or occupancy that the market would 
ever have expected from our type of business. We are an office 
occupancy.
    So I think that best explains the change of environment 
that was created on September 11. Whatever is done here, we 
believe must be a partnership between the Government and 
private industry. It should be short-term. We need something 
that gets us beyond January 1. And as my colleagues have said 
already, the devil is in the details. But our view is that we 
do not like Government involved in our business. That is not 
good for us because we are in the risk advisory business. And 
when the Government takes over part of that, that gets into our 
advice piece. The same thing is true with the risk-bearing 
part. If they constantly give off risk to the Government, they 
are losing part of their business. This has to be temporary, 
but right now, for the consumer, we need a partnership 
between the Government and private industry.
    Thank you, Mr. Chairman.
    Chairman Sarbanes. Well, thank you very much. I thank all 
of the panel. And Mr. Sinnott, we understand, of course, that 
the first plane that hit the towers hit directly into your 
offices.
    Mr. Sinnott. That is right.
    Chairman Sarbanes. And we certainly extend our sympathies 
to your corporate family. I understand that you lost 295 people 
out of 1,900. You had offices in both towers?
    Mr. Sinnott. In both. Everyone got out of the south tower. 
We had about 900 there, which was where the second plane hit. 
But anyone who was on our floor in the north tower, no one got 
out.
    Chairman Sarbanes. I am going to ask a few questions just 
to try to get some sense of the parameters of this. What 
percent of the loss that you are estimate--you say 25 to 40, 
you took the high figure. I mean, who knows, in a sense, but in 
any event--is property and casualty and what percent would be 
life and health? Do you have any idea?
    Mr. Vagley. Yes. We have estimates, Mr. Chairman. Let us 
stick with the 40 for the minute, and I certainly take Mr. 
Sinnott's point of view, it could be higher. But let us stick 
with that for the moment. The estimate would be about $5 
billion of that 40 would be life and health.
    Chairman Sarbanes. Is what we would do here set a precedent 
for what we might have to do for life and health? Since we are 
now worried about bioterrorism, chemical, things of that sort. 
Do we have to keep that in mind as we work on this problem?
    Mr. Vagley. My opinion would be yes.
    Mr. Sinnott. I am less sure. Because even with the life 
insurance industry which is a vast industry with individuals--
let's face it, it happens every day. We have not to date had 
the same issues raised on the life side that we have had on the 
property/casualty side.
    Chairman Sarbanes. Yes, I know. But this event, this 
terrorist event was one that by its nature impacted financially 
at least more greatly I think on the property and casualty 
side. But you could have a terrorist event, as we are now 
seeing as we deal with anthrax. If you refer back to the 
chemicals in the Tokyo subway and things of that sort, which 
would come down heavy on the life and health problem.
    Mr. Ferguson. May I add that I think the key phrase that 
Mr. Sinnott used is ``to date.'' And the life industry will 
handle this one just fine. But you are absolutely right, Mr. 
Chairman. I think we have to think beyond this particular 
event. And I almost hate to say it, we have to think about 
nuclear terrorism where then the life insurance industry could 
be very seriously affected.
    We all tend to think about the life insurance industry as 
being huge, which by some measures it is. But I must tell you 
that the capital base of the life insurance industry in round 
numbers is about $200 billion. It is not the behemoth that many 
of us might think it is. And you can imagine, as you have just 
started to, terrorism scenarios where it would affect the life 
insurance industry.
    Chairman Sarbanes. Mr. Vagley, you said in your--and I am 
just trying to get a sense of the parameters here. We have to 
understand the lay of the land. You say on in your testimony, 
``Our only remaining option--this is if something were not done 
here . . .'' and ``. . . one we would not prefer to consider 
would be to simply withdraw from certain markets, and/or lines 
of coverage.'' What markets would you anticipate insurers would 
withdraw from?
    Mr. Vagley. Again, Mr. Chairman, with the same reluctance 
that Mr. Ferguson shared, because you almost hate to identify 
these areas for fear that somebody will act on them. But 
certainly there are a number of American companies that are 
icons, that are very visible targets. There are a number of 
American industries that it would not require a great stretch 
of the imagination to believe would be exposed. Certainly large 
office buildings in major cities, transportation networks, 
electric utilities, petroleum facilities. There are a number of 
businesses that would seem to be more at risk than others.
    Chairman Sarbanes. And lines of coverage?
    Mr. Vagley. Well, lines of coverage, some of the most 
exposed here, workers' compensation would be a very precarious 
line of coverage. I think the losses coming out of the World 
Trade Center for workers' compensation could indeed be 
staggering and could even reach or exceed some of the 
commercial property losses. And some of these markets, Mr. 
Chairman, already are firming up and are considered hard 
markets.
    Chairman Sarbanes. Yesterday the NAIC President, Kathleen 
Sebelius, who is the Insurance Commissioner in Kansas--this 
goes to the duration issue that someone raised at the table--
she said, ``Well, you know, if this had been February instead 
of September, that there might have been enough time for the 
industry to have sorted it out before the renewal questions 
came up.'' What is your reaction to that?
    Mr. Ferguson. In a very narrow sense, you can make that 
argument. But I would have to broaden it and say that it is a 
problem today. You know, all those policies, as I mentioned a 
moment ago, that were in existence on September 10 are still 
affording this coverage today. And if we have a couple of more 
events like September 11, you are going to have a serious 
impairment of the capital of the property/casualty business. 
That could be February, that could be October. It would not 
matter.
    So in the narrow sense, I agree with her. There is a little 
broader issue here, the financial solidity of the industry 
which is exposed every day of the year.
    Mr. Sinnott. I would add to that. I would say that 10 extra 
months would help because there would be the opportunity to 
develop more capacity and capital in the market. By the same 
token, the environment is still the same today as if this had 
happened in February. And we are no more secure in that regard. 
So there is two parts to this. There is the environment and the 
ability to secure. I do not think we will ever get back to the 
way we were before September 11.
    Remember in 1993 when we had the terrorist attack, no one 
was sitting here saying we needed help, because there was not a 
perception that the environment had changed that radically. So 
that is an important issue as well in the timing.
    Chairman Sarbanes. I am going to impose on my colleagues 
and go on with just a couple of more questions. Mr. Baker, I 
wanted to ask you, from the banker's point of view, is there a 
difference on the insurance question between existing 
structures and new development as you would evaluate the 
insurance issue?
    Mr. Baker. Mr. Chairman, we will look at all of our 
customers the same way. In other words, we will go forward with 
existing customers. The question I suppose that is apparent 
right now is the need to renew policies as we go forward and 
the changing of the risk structure for these people, not just 
because of their loans from us but because of their position 
and their own risk evaluation in the marketplace.
    So our view of them will not change. I think as we look 
forward, this becomes an economic issue as we try to think 
about what can be done for our customers. So I do not believe 
there will be any disparity in how we treat existing customers 
or new ones. We do have this renewal issue coming up where we 
have a lot of policies that will come up for renewal between 
now and the end of the year, and that is what gives some 
urgency to this.
    Chairman Sarbanes. There is some discussion about whether 
the Government should share upfront. That was discussed here 
yesterday and has been debated by others.
    I take it from the industry point of view, of course you do 
not want the figure to be large--you would rather it be smaller 
than larger--but it is important to you to have a figure that 
would represent your exposure. Then you could calculate. Is 
that correct?
    Mr. Ferguson. In a word, yes.
    Chairman Sarbanes. I mean, whether it was $20, $30, $40 
billion, whatever. If you knew that and whatever the formulas 
were that the balance then would go off on the Government, at 
least you could calculate where you are. Is that correct?
    Mr. Ferguson. Yes. You begin to have some certainty and you 
could begin with admittedly crude pricing and underwriting 
tools to try to do it.
    Chairman Sarbanes. Now on the question of certainty, the 
Treasury's proposal, if you get over $100 billion says--and I 
am looking at their chart--``discretion of Congress.'' Now that 
is not a lot of certainty I would think.
    [Laughter.]
    Chairman Sarbanes. On the other hand, the figure is very 
large--very large. Now how would you handle that? Essentially 
figure, one, we may never get there? And two, if we do get 
there, Congress will, in fact, do something, and therefore it 
is taken out of the pricing equation?
    Mr. Ferguson. Well, you have correctly framed the bet that 
you as a company would have to make. And I cannot predict how 
individual companies would react. You have framed the argument 
exactly. Some companies would look at it and say the $100 
billion is sufficiently large. The risk of a frequency, a 
number of events is sufficiently remote that we feel we can 
underwrite and accept risk in this environment. Other companies 
may look at it and say it is not enough. It does not give me 
enough certainty.
    So we cannot, Mr. Chairman, in advance predict how 
individual companies would react. Sorry to give you kind of a 
wishy-washy answer.
    Chairman Sarbanes. This may be an admission against 
interest, but if I were trying to calculate how much of a 
burden I think the industry should carry, given its financial 
position, what figures would I look at? What indices would I 
look at in order to make some calculation in that regard?
    Mr. Ferguson. I would start, respectfully, with Exhibit A 
in my attachment to the prepared testimony where I make the 
case that the capital base on September 10 for the affected 
lines of business is about $125 billion. And as I say, some 
experts think my number is a little high, but let us stick with 
it for discussion purposes.
    So we need to look at that. You know, that capital base is 
supporting all of the commercial business, commercial lines 
insurance business in the United States. All the operating 
risks that attend that business, investment risks that attend 
that business. So it is not a huge capital base. It is big, but 
it is not huge. So that would be one of the indices that I 
would look at.
    Another statistic to look at is the amount of premiums in 
the commercial lines insurance sector and in round numbers--
this is workers' compensation, property, general liability, and 
so on, business interruption insurance, add it all up--in round 
numbers, it is about $145 billion of premium annually. So that 
is another factoid or another statistic that enters the 
equation.
    But to me, the important one is the first one. What is the 
capital base that is supporting this business? And how many 
September 11's can we handle? And the answer is, we can do this 
one, but I do not know what happens after that on the existing 
capital base.
    Mr. Sinnott. I might----
    Senator Dodd. You ought to review these numbers, by the 
way. The first number on the capital is very important.
    Mr. Sinnott. Did that number, represent just U.S. 
companies?
    Mr. Ferguson. Oh, yes. U.S.-licensed companies.
    Mr. Sinnott. Okay. Therefore, it does not include capital 
outside the United States?
    Mr. Ferguson. That is correct.
    Mr. Sinnott. I would add to that, the fact that our 
business is a global business. Reinsurance carriers, alien 
carriers who provide capital need to be included. So if I 
calculated it, I think my number might be up. The United States 
has at least half of the surplus that exists in the world, 
about half is what it is.
    So you could make a calculation. I might come up with 
something higher, but it is still not some of the numbers that 
have been thrown out as to the assets and such that the 
industry has.
    Mr. Vagley. Mr. Chairman, if I could add further, clearly a 
part of the calculation could be, should be, how much more pain 
can the industry bear? But the focus really ought to be on what 
will it take to restore the marketplace. And simple economics 
will suggest that the higher the amount the industry is 
required to retain, the more reluctance the industry will have 
to move comfortably back into this market, even uncomfortably 
back into this market, and the greater the retention levels, 
the greater will have to be the price of that coverage to the 
policyholders. I mean, there is no way to escape those 
fundamental economic principles.
    Chairman Sarbanes. Well, if you knew what your exposure 
was, you could calculate what the premium level had to be to 
cover that exposure, could you not?
    Mr. Vagley. Well right now the exposure is infinite.
    Chairman Sarbanes. No, no. I understand that. If you are 
dealing with an infinite.
    Mr. Vagley. Just some plan to be sure. And the more that 
retention is constrained and made definite and comprehensible, 
the greater will be the ability of the industry to move back 
into those markets and to take on those risks.
    Chairman Sarbanes. Now are you suggesting--well, I will 
wait and do it on the next round. I yield to Senator Gramm.

                STATEMENT OF SENATOR PHIL GRAMM

    Senator Gramm. Thank you, Mr. Chairman. Let me just say in 
terms of capital levels, we have to be very careful. A witness 
at these hearings yesterday suggested that the existing capital 
level of the industry told us something about our ability to 
extract that as part of some kind of mandatory process. The 
bottom line is, no matter what your capital is, you are not 
going to invest it unless you believe that ultimately you can 
end up selling a viable product.
    It is always tempting to say, well, let us pool the assets 
of this industry and then I will be able to afford these 
things. The problem is, it is other people's money.
    I do not expect any insurance company to put its capital at 
risk in an enterprise that has no hope of being successful. We 
had better be sure we organize what we do based on that thesis.
    Let me make a couple of comments and then I want to pose a 
question or two since I missed the opening statement. First of 
all, I would like to say that I think the insurance industry 
has been about as responsible as any industry in America. And 
people often accuse me of being pro-business. Actually, I am 
pro-free enterprise, and I agree with Adam Smith's observation 
that, ``Never do two merchants meet even for merriment lest the 
topic turn to conspiracy and restraint of trade.''
    [Laughter.]
    Senator Gramm. So I am not free with my compliments to 
businesspeople, and I just want to say that I think the 
position of the insurance industry and the people who run it 
has been about as admirable as any business that has dealt with 
this crisis. You are not at the heart of it like firemen and 
policemen in New York, but in terms of the secondary effect, 
pretty substantially affected.
    We had a talk this morning with Jose Montemayor, who is our 
Insurance Commissioner in Texas. And in our State, you can 
cancel a policy with 7 days' notice. We are already beginning 
to see some terrorism policies canceled with regard to private 
aviation, which makes it very difficult for these charter 
companies to fly into big airports. So we are already beginning 
to see an effect. I do think it is interesting. My State is 
about as proud of its rights as any State in the Union. We were 
a country at one time.
    [Laughter.]
    Senator Gramm. But here are the points that our insurance 
commissioner made about the whole State sovereignty issue. That 
as long as whatever we are doing is limited to terrorism, he is 
not worried about infringements on States' insurance powers. 
And as long as it is limited to 2 or 3 years, he is not worried 
about it. And I think that is pretty important. I am not saying 
he speaks for every insurance commissioner in the country, but 
I think that is relevant. That if it is very narrowly defined 
terrorism where we are going to define it in law and perhaps 
have a panel--the Secretary of the Treasury, the Attorney 
General and the head of the Federal Reserve Bank--based on that 
law, make a determination when an act occurs, is this 
terrorism, and we are not going to let the media decide whether 
it is terrorism or not, on that basis, what we do there is 
going to be a lot more acceptable within those narrow limits 
than if we were talking about a Federal action in insurance 
that was going to have a profound and lasting effect on the 
States. And, if we are talking about a 2 or 3 year emergency 
program, I think people understand and they do not see it as a 
precedent for the Federal Government taking powers away from 
States.
    It is clear from our hearings we had yesterday that on a 
bipartisan basis that for us to do a bill--and I think The Wall 
Street Journal article says it correctly. In fact, I said a 
similar thing before I read it and I totally agree with what 
they said. And that is, my guess is that we might be able to 
get through this thing without a Federal program. I just think 
the risk of doing that is too great. And I am not willing to 
take the risk.
    I think listening to the people we listened to yesterday on 
this Committee on a bipartisan basis, we are going to have to 
have some degree of retention so that the Federal Government is 
not the first dollar payor. We could debate as to what that was 
going to be. The Administration has a proposal where that is 
the case in the second year, not the first. And a simple way of 
bringing us together with the Administration would be just to 
make their second year program the first year program.
    The President's proposal, other than the first year, has a 
lot of good features and it is a very good start for us to work 
with. And for us to do something in 2 weeks, there is no way we 
are going to write a program and get into a debate with the 
Administration or get involved in any partisanship and get that 
job done. It is distinctly possible we might not get it done. 
And that it is important that everybody make an effort to make 
it happen. I just want to assure you of my best faith effort to 
see that we do get it done.
    Let me ask you a question. In 1993, we had a group of 
terrorists try to blow up the World Trade Center. What happened 
to insurance property and casualty rates after that? What 
happened to them in 1994 and 1995?
    Mr. Sinnott. I do not recall a great impact. I mean, it was 
a catastrophe, but, you know, it was not as big as Hurricane 
Andrew or some of the other catastrophes like Northridge 
Earthquake. In total, it was less than $1 billion.
    Senator Gramm. No, I am not talking about the cost in 
paying out of your reserves. I am talking about changing 
expectations. I mean, we had had a terrorist attack. People had 
tried to blow up the World Trade Center. Did anybody 
reevaluate--is there any evidence that anybody reevaluated and 
said, well, if we are going to provide terrorist insurance, 
maybe there should be a change in the rates that we charge? I 
am just trying to see how sensitive the market was to that.
    Mr. Sinnott. From a broker's standpoint, we did not see a 
change. The result of terrorist acts has been covered in the 
United States under insurance policies. That is not necessarily 
the standard in all parts of the world, but here it has been. 
And I think the World Trade Center at that time, as I recall, 
was viewed as, okay. That is what insurance is all about.
    Senator Gramm. So you did not see any change in premiums?
    Mr. Ferguson. That is my recollection as well. It did not 
create much of a ripple in the market. It should have been a 
wake-up call, but it was not. And to take Mr. Sinnott's point, 
it was regarded as a discrepancy, and it was not of such a 
magnitude that it caused huge problems for the industry. What 
we are facing now, of course, is a whole different category 
where we see a systematic aura of terrorism. No one thought 
that in 1993. Maybe we should have, but we did not. The short 
answer to your question is, it did not really create much of a 
ripple in the industry.
    Mr. Baker. Senator, I think it is important to remember 
that in that incident also the system worked. The industry kept 
going. Insurance was available. We did not have any problems.
    Senator Gramm. Let me say, Mr. Chairman, that I think again 
what we are going to have to decide is are we willing to take 
the risk that we are going to have a huge spike in insurance 
rates and generate an economic ripple in the economy of some 
substantial size? Or can we come up with a workable, short-term 
program to help us build a bridge to where hopefully we will 
eliminate much of the threat, and that ultimately this can be 
built into the structure of the system, and the Federal 
Government can get out? I think that is everybody's goal. I had 
not heard anybody on this Committee or in Congress or anybody I 
am talking to talking about getting the Federal Government 
permanently into the insurance business.

            STATEMENT OF SENATOR CHRISTOPHER J. DODD

    Senator Dodd. [Presiding.] Thank you. Senator Sarbanes will 
be back. Let me again apologize to my colleagues for not being 
here yesterday. But I had a staff member who had been with me a 
long time who lost her mother, so I was at a funeral in upstate 
New York all morning and afternoon yesterday. So I apologize.
    I think for us not to act is too high a risk in my opinion. 
What we do has to be done carefully because we are dealing with 
100 Members of this body and 435 in the other. And apparently 
there is some reluctance on the part of the House to move on 
some legislation here. I hope that mood is changing a bit. I 
know that people have been talking to them.
    I worked with Bob Bennett of Utah on the Y2K Committee. We 
spent 2 years urging business and industry, Governmental 
entities to make corrections and to get up to speed. And when 
the clock turned, the world did not collapse. And there were 
some who looked around and said, well, what did we waste our 
time doing that for? It is always hard to prove a negative I 
suppose, except that I can tell you the other day I was in 
Ground Zero in New York at the operations center there.
    The fellow who took me around had no idea that I had been 
involved in the Y2K issue but volunteered and said, you know, I 
do not know who was responsible for it, but had it not been for 
that effort made on this Y2K stuff, this operation center would 
not exist. Because the Federal Government pushed us to 
modernize, to update, to correct our systems, we were able to 
put in place a system here that has allowed us to respond to 
this savage attack in ways we could not have even imagined 
without the Y2K effort.
    And so my hope would be we will act, and in doing so, will 
avoid the kind of problems that have occurred. I am sure there 
will be those who then say, well, you did not need to act. So I 
agree with Phil Gramm that for us not do something here would 
be highly irresponsible. We are talking about stimulus packages 
that are going to be passed to try and shore up a weak economy. 
And in my view, it would be a huge mistake if we were to take 
some sensible action there and not do something here.
    Ron, it was in your statement--I believe it was in yours. 
No, Les Baker. There you are right there. You said this. I 
think it is true. Is it prudent to make a loan to construct a 
pipeline, a power plant, an airplane, or a ship, a large 
shopping center, or an office building when the potential for 
the borrower to repay the loan is diminished by inadequate 
insurance coverage? For most banks, the answer will be no. And 
that is the real danger we face here.
    So this is really--we have insurance here. We are going to 
hear from Tom Donohue and others--but this is far more of an 
economic issue than an insurance issue. And there is a tendency 
to talk about this in insurance terms, which is obviously 
important, because the industry is involved directly. But the 
people who are going to be adversely affected here if the 
insurance does not show up in January with 70 percent of these 
contracts are up for renewal in about 8 weeks, and if they are 
not renewed, the insurance industry will be here. The question 
is, is whether or not those other industries out there that 
depend upon that insurance are going to be able to survive.
    So when we have our hearings about the effects of all of 
this, we will have a very viable insurance industry at the end 
of all of this, but we may not have a viable economy or 
economic interests as a result of our failure to act.
    So my hope is that we will. There is no perfect plan, and 
it ought to be relatively short-term in my view if we are going 
to do something in a way that we can come back and during that 
period of time review maybe on a longer-term basis what steps 
need to be taken to improve the potential for the damage to be 
caused by terrorist acts.
    So the question of capacity I was going to raise with you 
which you have already indicated where we stand with the 
capacity issues, but let me ask this panel if I can, first of 
all just quickly, two questions. One is, I mentioned short 
duration. We have been talking about 2 years with a possible 
third year with the President giving that authority. I would 
like you to comment on whether or not that is adequate or too 
long. And then second, I would like you just to mention and 
respond if you could to the effects on the economy, what your 
own thoughts would be in terms of what this could mean if we do 
not act here and come up with a plan that works.
    And then last let me just say, my view is the economic 
interests always are important, but I worry deeply. This 
economy begins to crater more. You are going to watch a public 
reaction that is going to have an impact on policy setting in 
dealing with September 11 and other events. You have 
unemployment rates going up. You have interest rates and all of 
these problems that are going to create tremendous pressures on 
our society, and that is we have to be very mindful of. And we 
do not want to make the perfect enemy of the good here, and we 
realize we are sailing in some uncharted waters, but it is my 
hope we would be willing to take a chance and do something that 
I think would protect against a far greater tragedy occurring 
if we did not act.
    So with that, Mr. Chairman, I thank you immensely for 
holding these hearings. They have been very worthwhile. And my 
hope is that we will move very quickly now and come up with a 
proposal here that we can present to our colleagues, and 
hopefully one that will enjoy broad-based support. All of us 
who have been around here any length of time will tell you, at 
this stage of the year, 
the clock is the 101st Senator and a tiny group of people could 
be highly disruptive in terms of stopping something from 
happening. And my hope is that our colleagues will recognize 
the potential dangers here of not acting and will help us 
construct a plan here that will provide the needed assurance 
and help. And I again want to compliment the industry for 
acting so responsibly. Just those two questions if you want to 
comment on duration and economic impact.
    Mr. Vagley. Senator Dodd, thank you very much. And in your 
absence and Senator Gramm's absence, I really thank you and 
would like to do so again for your extraordinary leadership, 
your joint leadership on this very important issue.
    I certainly agree with the sentiments that you both have 
expressed in the last several minutes and the challenges to 
restore some stability in the commercial insurance marketplace. 
It is not about saving insurance companies. We do not need to 
be saved in that respect. The consequences really fall more 
broadly on the American economy.
    With respect to your two questions, I think from our 
standpoint, longer is better than shorter because it does 
correlate with stability. But the kind of architecture that you 
and Senator Gramm have described is perfectly adequate in light 
of the business and the political circumstances and would 
provide a sufficient bridge to get us through this period, and 
perhaps in the calm of the fullness of time, the industry could 
get more comfortable with this, the marketplace could settle 
down, and private mechanisms could begin to move in, or there 
might be a determination made that some additional support 
needs to be provided.
    I think with respect to the economic dislocations, there 
are others on the panel who are better suited to speak to that 
than me. But without engaging in too much hyperbole, we are on 
the frontlines of a growing economic crisis. We are seeing it 
already in the lack of reinsurance availability, which is 
washing back on us, and that is translating currently into the 
lack of insurance availability, and that message is beginning 
to impact the business community at large. But there may be a 
lag time there in terms of the kinds of communications you are 
hearing from businesses generally, but I promise you it is 
there and it is going to wash over that community very soon.
    Mr. Ferguson. Senator Dodd, as to the period, my personal 
opinion is, 2 to 3 years is the minimum. I hope and think that 
can work. If we look for historical precedent and look back at 
the nuclear energy reinsurance program and the urban riot 
reinsurance program, it did take longer. I am not saying that 
is a perfect precedent, but it did take about 10 years for 
those things to settle down. I certainly hope that is not the 
case here. We as citizens cannot afford to wait that long. So I 
think 2 to 3 years is the minimum is the short answer.
    As for the economy, obviously the frontline where you are 
going to see it first, as Mr. Baker indicated and Mr. Bartlett 
has indicated in comments, is going to be in lending. Quickly 
behind that, the real estate industry. And then you get into 
kind of the confidence factor, and then the second and third 
order effects that I do not know how to judge any better than 
anyone else, but it really gets to the confidence and 
predictability factor that Mr. Baker was talking about before.
    Mr. Sinnott. On the duration question, I have two answers 
to that. If the environment does not change, let us say we are 
sitting here a year from now and there is no change in the 
environment, in my view, will there be more private capacity 
available? Yes, there will be more capital. There is more 
capital coming in now in general across the board. And that 
will include, the ability to mitigate the withdrawal that is 
taking place. That will be very slow. And as I said earlier, if 
there is no change in the environment, however, a year from 
now, it is a matter of degree. There will still need to be 
Government involvement.
    If however the environment is secure, and we no longer see 
on television the ``Attack on America'' and we are some way 
able to get back anywhere close to the way we were before, 
then, we can accelerate the withdrawal of the Government. But, 
you know, there are two issues there.
    And on the investment side, Mr. Baker probably has the best 
answer on this or the best information, but I can think of one, 
and that is large construction projects, which involve not just 
physical assets but significant numbers of workers, so you have 
both workers' comp and you have big asset values. If there is 
not adequate insurance for those particular projects, they will 
not go forward.
    Senator Dodd. Mr. Baker.
    Mr. Baker. Mr. Chairman, I would make a brief comment on 
the duration issue from a banking standpoint simply to say that 
a great deal of our financing is in the 2 to 3 year range, and 
so when we look at projects, it could be a big project, a large 
office building or a power plant, typically things take a while 
to get built. So you have to begin to think of this link to 
projects. That is the best guidance I can give you on duration 
that you are trying to bring stability to the market over time.
    On the economy, I would like to address this, because I 
think it is critically important at this time. I would like to 
say first that I am an absolute optimist on the American 
economy. I believe that when you look at the demographics, for 
example of North America, the population will increase about 40 
percent over the next 50 years. It virtually assures us of a 
growing, sound economy over the first half of this century. So 
put me in the optimist column.
    Right now the weakness that we are seeing is a global 
weakness in the economy. It is lower nominal growth within our 
domestic economy, and now it is very severe employment 
pressure. We lost something on the order of 77,000 jobs out of 
the economy in the last week alone. So my sense of this is, it 
is a very critical point right now, because I believe the 
American consumer is in the process of making up his or her 
mind about where this economy is going to grow. And so 
stability is important. And what we do not want to see happen 
is to see the economy lapse back into a self-defeating 
proposition. We do have this global weakness in Europe, Latin 
America, and Asia.
    I would like to finish my comments by saying that I think 
particularly this is a small business issue. We tend to focus 
on large power plants and things like that, but I think this is 
particularly difficult for small business. I think you should 
consider the business interruption insurance. That is a small 
business issue if there ever was one. So that is the critical 
thing on the economy. The economy is going to grow. It is going 
to be good, but it is a very critical point right now.
    Chairman Sarbanes. [Presiding.] Thank you very much.
    Senator Corzine.

              STATEMENT OF SENATOR JON S. CORZINE

    Senator Corzine. Thank you very much, Mr. Chairman. I 
apologize to the panel for being late. I was at another 
hearing, but I too would like to give my congratulations and 
laud you for how the industry has reacted in the post-September 
11 time. It has been very responsible.
    I have a question with respect to the knowledge base that 
you think you will have gained over the next 2 or 3 years in 
this exercise of bridging which we are about. Is this the kind 
of activity that we can bring actuarial knowledge and 
applications to in a way that you might be able to deal with 
natural disasters? I am very much of the view that the long-run 
solution may have to wait so that we can be careful about the 
short-run. I am troubled with the assumption that somehow or 
another we are going to have actuarial knowledge with regard to 
crazy behavior that comes from terrorism. I would love to hear 
your propositions on that.
    Mr. Baker, you talked about 2 or 3 year financing programs 
through the banking industry, but as you know, there are other 
capital markets that have longer duration, and what kind of 
impact do you think a short duration program may have with 
regard to the free flow of capital? And have we seen any 
indication that that may be drying or at least dampening down? 
I do believe this is a serious economic dislocation issue that 
needs to be addressed, and the business interruption issue with 
regard to small business, I would love to hear your comments.
    And I would love to be respectful to my colleague, Senator 
Stabenow, who had to leave, but she was very interested in 
understanding whether if we implemented this bridge program for 
2 or 3 years, do you anticipate insurance rates for consumers 
in particular would stay the same or go up? Would you be 
withdrawing from lines? I ask any and all of you to take on any 
piece of that.
    Mr. Baker. Senator, you are the expert on debt markets, and 
so I will not try to----
    Senator Dodd. He would like you to bring that microphone 
and say that again.
    [Laughter.]
    Mr. Baker. I think there are markets where financing is of 
longer term, but the point should be made that these markets 
are very sensitive. And when we have issues that come up, we 
see debt markets that have cracked almost immediately. We see 
difficulties in risk assessment. So what plea I would make here 
this morning is as we are looking for continuity and stability 
in the underlying economy, that is what keeps debt markets 
going.
    Senator Corzine. The commitment committee process that you 
have at a bank on an interim financing basis is not unlike what 
you would have in putting together a prospectus of investors.
    Mr. Baker. I was just trying to logically think about the 
kind of project time that you have when you build a building or 
a power plant. On your point, if I may say so, about risk 
assessment, there are pretty startling things going on in that 
field, so my guess is we will learn a lot from this and other 
events as we go forward.
    Mr. Sinnott. I will comment on the rates and the actuarial 
question. Ron would probably have good ideas on this. We do it 
through our reinsurance broking operation. We do modeling, and 
that is catastrophe modeling for earthquakes, hurricanes. And 
to do that modeling, you do need some frequency. So I will have 
to go back and ask some of my modeling experts. But I am a bit 
skeptical. We do not want frequency, that is for sure here.
    I think that they would probably say if we do not have that 
frequency, which we hope we do not, it is very difficult to 
model something like this, and if you cannot model it, it is 
difficult to come up with any actuarial precision.
    The second part as to the consumer, the business consumer 
in this particular case, what will happen with rates? Rates 
have gone up very significantly already. Since September 11, we 
have seen property rates go up on average, that includes 
business interruptions, 65 percent sometimes 100 percent, 
sometimes 150 percent. Do I expect if I were sitting here a 
year from now that will have moderated? No, I do not think it 
will have moderated.
    We went through 13 years of a very soft market from 1987 on 
to 2000, and if you look at the loss experience, and again, my 
colleagues here can speak to that directly since they were 
impacted, but if you look at the loss record for the industry 
up to that point absent September 11, particularly in property, 
it was not good to say the least.
    So I would have said I do not expect that we are going to 
see another 65 percent, but I am just saying I do not think we 
are going to see a moderation of rate increases. And I guess 
the question is, are we dealing with that with our clients? 
Yes, we are dealing with that.
    Three aspects: There is capacity, the scope of coverage, 
and there is cost. We do not play loosely with our clients' 
money. But scope of coverage is the thing that can really be 
extremely harmful to the security that insurance is supposed to 
provide. And what we are talking about here is scope of 
coverage.
    There is capacity loss as well. The capacity issue we can 
deal with, capacity across the board, not just for terrorism. 
There is a reduction in capacity. So that is my view, Mr. 
Chairman.
    Mr. Ferguson. Senator Corzine, first with respect to your 
colleague's question, I agree with Mr. Sinnott. It is important 
that we realize there are two things going on here. We are 
coming off a sustained period of poor returns in the insurance 
business that has nothing to do with the tragic events of 
September 11. If it had never happened rates would still be 
going up for that fact.
    It is awfully hard, as you would note, to break that 
envelope apart. You know, which part is going to be 
attributable to the September 11, and which part is 
attributable to the fact that the industry was earning subpar 
returns?
    With respect to the actuarial point, if I may, you are 
absolutely right. There is no actuarial technique. There is no 
statistical extrapolative process that allows you to deal with 
one horrible data point. We can try to take the Bayesian 
approach, and if we get two data points maybe we will make 
something of it, but we all hope that we only have one data 
point. So my real answer to your question is this. As long as 
the actuaries and the underwriters can put this in a box--by 
that, I mean know with reasonable certainty what they are 
signing up for when they write a risk--they will be willing to 
exercise their collective judgment. It will not be actuarially 
based. It will not be statistically based. It will be the 
judgment of underwriters and pricers who have been doing this, 
admittedly not terrorist coverage, for decades.
    The insurance business kind of lives by its wits in that 
there is not a nice black box. You do not know the cost of 
goods sold, let us put it that way, beforehand. But if we know 
what the box is, you are going to find underwriters that are 
willing to step up to the challenge, even though it will not be 
actuarially based.
    Mr. Vagley. There is little I can add to the views of the 
businesspeople, Senator. In terms of actuarial experience, I am 
reminded by something I read recently which was, in the light 
of the IRA attacks in Central London, it took the London market 
about 5 years to get comfortable with doing that business 
again. So there is a period of experience that will promote 
stability if here, assuming, again, and the important 
assumption of no additional terrorist acts, which could create 
even further angst and anxiety.
    And in terms of rates, maybe juxtaposing what might happen 
on January 1, which is commercial insurance for some risks 
simply will not be available is a way of making the comparison. 
There may well be in the absence of support no rate which is 
acceptable to an underwriter to write that risk.
    Chairman Sarbanes. Senator Reed.

                  COMMENT OF SENATOR JACK REED

    Senator Reed. Thank you very much, Mr. Chairman. Gentlemen, 
thank you for your testimony. This is a critical issue that is 
in need of your attention and your testimony today. Let me just 
ask a few questions. Unlike my colleagues, I am not an expert 
in debt.
    [Laughter.]
    Senator Dodd. We are all involved in debt.
    Senator Reed. But I cannot make money on my debt.
    [Laughter.]
    Chairman Sarbanes. He is an expert on other people's debt.
    Senator Reed. Let us talk about other people's insurance 
for the moment. Both proposals are on the table. You have a 
proposal from the White House and you have a proposal from the 
industry. I apologize if I am covering ground that has already 
been trodded, but is there any way that if either of these 
proposals is adopted we can guarantee affordable, available 
coverage to reasonably secure risk?
    Mr. Sinnott.
    Mr. Sinnott. Yes. In my view, if there is coverage in the 
broadest sense as there has been, as I said a moment ago, yes, 
prices have gone up, but I deem that to be something that can 
be dealt with by the business consumers.
    Senator Reed. So your view is that if we enact either one 
of these points that we can create a climate where it might be 
more expensive but only marginally so, that we effectively 
could secure in a reasonable way the risk we face going 
forward?
    Mr. Sinnott. Yes. Because particularly where you are 
looking at a situation that maintains competition, and there 
still is competition out there amongst the insurance companies, 
and they are looking at their rates, yes, I think we can.
    Senator Reed. Now again, these plans are rather 
complicated, but the industry plan as I understand it would set 
up initially a pool which would take the risk, and if the pool 
is exhausted, the Government would step in. So in a sense, the 
first industry proposal has the industry absorbing risk to a 
certain limit and not the Government. The White House plan, and 
again, I stand to be corrected if necessary, would have the 
first dollar of risk paid for by the Government. Is that a 
fair----
    Mr. Ferguson. In a word, yes. It is an 80/20 quota share, 
yes.
    Mr. Reed. Again, this goes to the notion which is common of 
someone paying a deductible first before the Government steps 
in or the insurance company steps in. Could you elaborate the 
industry's rationale for your proposal and why it might be 
better, different, or more effective than the White House 
proposal?
    Mr. Vagley. There are a number of proposals, Senator. The 
industry proposal was really advanced, it was really based on 
the British model and the British experience and the experience 
of other nations after they became unfortunate members of the 
terrorism-at-home club. Our model is predicated on their 
concept, which is called Pool Re. It simply is a way of taking 
risks that would be unfathomable for any particular company, a 
tall office building in a major metropolitan area, and in the 
absence of reinsurance, available commercial reinsurance 
coverage, in effect spreading that risk through a pooling 
mechanism, in effect creating a mutual insurance company into 
which all primary insurers would pool their risks, and that 
would be reinsured by the Government, acting itself as a 
reinsurer.
    That proposal has been effective in the United Kingdom. To 
my knowledge, the British government has not paid out a pound 
in liabilities. The Administration's proposal, which Ron 
described as a quota share, would provide at least in the 
initial year an 80/20 sharing of risk, Government and industry. 
In that proposal, although in our view perhaps not as efficient 
as the pool proposal, would also be effective because it would 
allow underwriters in a real sense to get their arms around the 
defined liability.
    Then there is a third proposal which has been discussed but 
not reduced to legislative form, which is in effect the 
deductible approach. That may be a little more difficult. And 
the industry may have to determine and create some mechanisms 
to deal with the retention level underneath it, because it does 
in a way present the same kinds of difficult underwriting risks 
that the status quo presents in terms of a real reluctance to 
write those big risks upfront because you could be eating 100 
percent of it instead of just 20 percent of it, say, in the 
Administration's proposal. But it can be made to work.
    And I guess our view, and this picks up on Senator Dodd's 
and Senator Gramm's statements is, there are the business 
imperatives which we understand very well, and then there are 
the political imperatives, which you understand far better than 
we do, and the challenge for us and I think the challenge for 
all of us is to find the common ground there. It may be that 
the proposals we think are the most efficient are simply 
indigestible in terms of the remaining time and the body 
politic.
    Senator Reed. Let me ask one final question or two if the 
time allows, certainly one. In essence, I know this is not 
designed to be a bailout of the industry. I know the purpose 
here is to allow ranges of business from small drycleaners to 
large office complexes to buy insurance at reasonable rates. 
But essentially, from a business perspective, you all will be 
laying off risk to other people. Typically, you pay for that in 
your industry. You pay a fee, you take your risk. In any of 
these proposals, would the industry be essentially paying a fee 
or paying anything to the Government to absorb risk?
    Mr. Vagley. The pool proposal does provide for payments by 
the industry to the Government for reinsurance.
    Mr. Reed. Mr. Ferguson.
    Mr. Ferguson. Just as a footnote on that, interestingly 
enough, the Pool Re in the United Kingdom, they had a different 
twist on it. Once the Pool Re accumulated assets of $1 billion 
I believe, then they were going to start to pay the reinsurance 
they were getting from the U.K. government. It was a slight 
twist on it.
    Mr. Reed. Thank you, Mr. Chairman.
    Chairman Sarbanes. Thank you.
    Senator Carper.

              COMMENTS OF SENATOR THOMAS R. CARPER

    Senator Carper. They gave us two microphones so we can talk 
out of either side of our mouths.
    [Laughter.]
    Senator Carper. Maybe you do not do that in Connecticut, I 
do not know. But I think they do.
    [Laughter.]
    Senator Carper. To our panelists, welcome. I have just come 
from another hearing. We all serve on a bunch of different 
committees, and as former Congressman Bartlett knows, you 
cannot be present at all of them, and I am going to ask you if 
I can just cover some ground that you have already covered 
that, but to the extent if you could do and do it quickly, I 
would be most grateful.
    Secretary O'Neill was here yesterday and laid out the 
Administration's proposal, which I thought had a fair amount of 
merit. They had obviously given it a good deal of 
consideration. If each of you could just take 30 seconds to add 
briefly to it please, what you like about it and what you do 
not.
    Mr. Baker. Senator, I am here representing the banking 
industry. From the standpoint that the economy is dangerously 
weakening, and this is a time when we probably need to work 
together to resolve that, we really have no view on the 
particular programs themselves or the merits of them, other 
than we probably need to do something sooner rather than later. 
And our own recommendation would be it should have a time limit 
and certain constraints put on it, as all these programs 
should.
    Senator Carper. In your testimony, did you lay out a number 
of principles? Someone did.
    Okay. Please.
    Chairman Sarbanes. We moved Mr. Baker up from the next 
panel. In fact, Mr. Baker, if you need to excuse yourself, you 
ought to go ahead.
    Mr. Sinnott. Our reaction to the Treasury proposal is 
favorable for these reasons. It can be enacted quickly. It is 
the least intrusive from a Government standpoint, the easiest 
to unwind. You do not need to staff up on the Government side 
to do this, and it is the least complex.
    The others are complex. Anytime you have an industry 
aggregate, there is questions as to who gets what and how the 
aggregate is accumulated. Having said that looking at it from 
the consumer standpoint, it should be seamless. As long as the 
industry and the Government are in partnership on this and it 
provides the ability for the insurance policy to not be 
restricted, then it becomes an internal seamless issue.
    I would say, though, that the one thing we would want to 
look at it again, because we also act as a reinsurance broker 
to the insurance companies, is how this mechanism would work. 
To make sure that it maximizes the amount of private industry 
you can get back into the market.
    Senator Carper. Thank you. Thirty seconds.
    Mr. Ferguson. First, I thought Secretary O'Neill just did a 
fantastic job of laying out the issues. I really applaud him. 
Second, any of the three proposals that are in play and being 
discussed could in theory work. Third, the devil is in the 
details. You might want to arm wrestle about whether the 80/20 
and the way it goes in the second year and the third year is 
the right parameters, but in theory, can it work? Yes, it can 
work.
    Senator Carper. Thank you. Twenty-nine seconds. That was 
good.
    Mr. Vagley. Senator, I thought what was perhaps most 
important about the Administration's proposal was clearly the 
recognition of the need that this was not a trivial or 
frivolous subject and another in a succession of industries 
seeking relief from the events of September 11. That was an 
important recognition. I think in terms of its basic structure, 
it is workable, it is relatively straightforward. In our view, 
the retention levels in the outyears are high. It would not 
necessarily promote the objectives of the legislation.
    Having said all that, however, I would like to indicate 
again, lest we seem to be preferring one plan over another, 
though perhaps we do, that we are for any plan that will help 
stabilize this market and that is politically feasible and are 
not wedded to the details of any particular proposal.
    Senator Carper. Thank you. I have been wrestling with a 
couple of different terms looking at a statement of Mr. 
Ferguson where you talk about adjusted commercial U.S. 
insurance property and casualty, possibility of a surplus of 
$126 billion. We have a staff briefing that was given to us 
where they talk about that surplus number is close to $300 
billion. I have a hard time reconciling that.
    Chairman Sarbanes. He has a table. He has worked that down.
    Mr. Ferguson. I can reconcile it very quickly. The $300 
billion is a correct number. Fire and life plus property and 
casualty, it is $300 billion. If you take the surplus that goes 
along with the companies that predominately write personal 
lines of business, your personal automobile, your homeowners 
and so on, and make a couple of other adjustments--I will not 
go through them, but you come down to the $125 billion. I can 
reconcile them.
    Senator Carper. Thanks. I would just observe in closing 
that we do not have a whole lot of time before the end of the 
year in terms of oversight and things. We need to move forward 
with some dispatch. And I will not quibble with what the 
Administration has proposed. It probably will change it to some 
extent. But it does have simplicity. And if I can understand 
it, it is a pretty good sign that others could as well. And to 
the extent that we can agree on something that is fairly simple 
and straightforward, we might actually be able to pass it to 
the House through the Senate and work it out with the White 
House and get it done in a timely matter.
    Thank you very much.
    Chairman Sarbanes. Well, gentlemen, thank you very much. 
Mr. Baker, you had better go. I am worried about you.
    [Laughter.]
    Chairman Sarbanes. I want to put a couple of questions to 
the others, so if you want to slip away. I want to ask a couple 
of very simplistic questions. If you have a major property or 
casualty loss in some geographic area of some sort which is in 
the ambit of the industry handling it on its own, do you then 
raise rates across the country to all your clients in order to 
make up for that hit, or do you localize the rate increase?
    Mr. Sinnott. A combination really. The individual policy 
that has sustained the loss at renewal, that is going to be 
recognized, just as good loss experience is recognized. But if 
the overall loss experience, as it has been, as we mentioned in 
the property area, is across the board, then everyone will have 
some degree of increase.
    Chairman Sarbanes. All right. I want to get a handle on the 
magnitude of this problem. What is the premium flow into the 
property and casualty business?
    Mr. Ferguson. For the commercial lines business, which 
would be the relevant base here, sir, that would be about $145 
billion. That is for everything.
    Chairman Sarbanes. One hundred forty-five billion dollars. 
Well, now the Treasury's proposal in Year Three would have the 
industry exposed for $36 billion.
    Mr. Ferguson. Correct.
    Chairman Sarbanes. Leaving aside for the moment the problem 
of in excess of $100 billion, which we discussed before, 
putting that to one side, and that was left in this black hole 
called the discretion of Congress.
    [Laughter.]
    Chairman Sarbanes. But putting that to one side, now, an 
increase as I calculate here of about 23 percent uniformly in 
your premium flow would cover that exposure. Is that correct? 
Do you cover it 100 percent or do you cover it a factor of 100 
percent?
    Mr. Ferguson. Your mathematics are impeccable. That is 
correct. The problem----
    Chairman Sarbanes. I know you have the problem that that is 
not exactly how you do it, but I am just trying to get a sense 
of----
    Mr. Ferguson. Your math is correct, but in practice, it 
would not work out that way because, of course, in some States 
and in some classes of business, it would be thought that they 
are not particularly targeted for terrorism and so they would 
have much less increases and others would have more. But I do 
not mean to quibble with your arithmetic.
    Chairman Sarbanes. The 150 is not homeowners.
    Mr. Ferguson. Correct. The 145 to 150 is commercial lines 
only. My best guess, Senator Gramm. Commercial lines only, 
workers' comp, property, general liability, roll it all up, 
about $145 billion.
    Chairman Sarbanes. All right. Now one other question. I did 
not understand Mr. Vagley. On the one hand, you say we should 
preserve rate review by appropriate State regulators. On the 
other hand, you seem to want to alter their process. Is that 
correct?
    Mr. Vagley. I think we would like to alter the process with 
respect to terrorism and rate review. However, there are State 
regulators who disagree with that.
    Chairman Sarbanes. Let me just say this just as 
observation. I have not discussed this with my colleagues. I am 
frank to tell you the simpler you keep this and the less you 
seek to change current arrangements, whatever they may be, I 
mean, the NAIC yesterday talked about consumer protection 
provisions. If this is envisioned as a vehicle for getting 
other type changes, it is going to significantly complicate it. 
You have a problem on the tort issue in my opinion. First of 
all, we do not have jurisdiction over that. We may run into a 
serious problem in that regard.
    Senator Dodd. That has never stopped the Committee up here 
before.
    [Laughter.]
    Senator Dodd. We claim the whole world as jurisdiction.
    Chairman Sarbanes. I understand, but it is highly relevant 
as we consider this, since we may have to assert jurisdictional 
lines in order to keep moving forward so we do not undercut our 
own case, if I may say so. But in any event, I just wanted to 
make that observation. People who have things up on the shelf 
they have been wanting to get and then they want to take them 
off the shelf and put them into this pot, that greatly 
complicates the stew.
    Senator Dodd. Let me just say that I agree with Senator 
Sarbanes on that point, too. That is something all of us feel. 
If we are going to get something done here, it has to be done 
very tightly. But I would put on the rate issue, we talked 
about this already, with the exception of some 12 States, and I 
may be wrong on that number, writing commercial insurance, that 
you set the rates and then the States-by-State law determine 
whether or not that rate is justifiable. And I do not know why 
you would want to change that.
    Mr. Vagley. We do not. As a matter of fact, it really was 
in recognition of precisely what you described; that this 
should be narrowly focused on terrorism risks and not seek to 
advance any other legislative agenda. That the proposal that we 
advanced was in compliance with that.
    And with respect to the two areas of potential State 
regulatory interference, even the State regulators are in 
agreement that it is necessary in the one instance to have a 
common definition of terrorism, for instance, where States 
cannot require greater coverage, so that in the worst of all 
worlds, there is incongruent coverage. And my understanding is 
even the States agree that a pricing mechanism such as we have 
advanced which does kind of cut the baby in half, it is a final 
use system consistent with what Senator Dodd said is 
understandable and agreeable, and we are not seeking any 
additional leverage or advantage even though we might prefer to 
do so. Our understanding, Senator, Mr. Chairman, is that this 
bill, if it is to advance, with all the difficulties of the 
remaining time available and all the circumstances surrounding 
the issue, must really be laser-like and focused on this 
principal issue.
    Chairman Sarbanes. Let me ask one other question just for 
my own enlightenment. What is your reaction if someone says why 
doesn't the Government just assume the responsibility for 
terrorism on the premise that one of the things the Government 
ought to be able to do is protect the society against 
terrorism, so we are not going to put this in the private 
sector. And if we have a terrorism attack and a loss, the 
Government will pay for it and the industry will go on about 
its business of ensuring the other kinds of risks that do not 
relate so directly to, in a sense, our national security.
    Mr. Ferguson. Senator, that argument can be advanced. I 
think it comes down to the philosophical issues. My own answer 
would be let us construct a plan where the private sector has 
the opportunity to return to normal and not put the Government 
permanently in the insurance business. But I recognize others 
will have different viewpoints.
    Mr. Sinnott. If I can add to that, there are other perils 
called riots, civil commotion, that governmental bodies, 
whether it is the local police force, are responsible for 
securing. I think that they are all manageable. They can all be 
dealt with in the private sector. Terrorism is another part of 
that. It can be dealt with so long as we are not in the 
situation that we are currently in.
    Senator Gramm. Mr. Chairman, first let me say that in terms 
of a Government program, We could do that, and there is some 
programs that could be adopted that would be, in my opinion, 
worse than a Government program. The problem is transitioning, 
the problem is how do you get out of it, and I know you are not 
proposing a Government program.
    Chairman Sarbanes. I am just trying to feel for the 
parameters of this.
    Senator Gramm. I think having tried to think through that 
in terms of my own preferences, the problem is not that the 
world would come to an end if the Federal Government said, in 
these narrowly defined areas, we are just going to cover it 
directly. The problem is how do we get out of it and how do we 
get the private sector into it. And then over time how do we 
keep it from growing where people want to broaden the 
definition of terrorism. So, at least, in my own mind, that is 
why I have rejected that.
    I would like to say that I think your point you made is the 
key to us getting this bill written, and that is if somebody 
wants to put something in here, the heavy burden of proof on 
them is you have to prove that it will not work or work well 
without it. I think if we begin with that premise, writing this 
bill will be doable, and there is not any other way to do it. I 
think Senator Dodd and I have felt for several years now that 
we had a real problem, if we had a major hurricane and we had 
an earthquake in the same year, and at some point, we have to 
come to grips with that. And I would prefer to do it by 
changing tax policy and letting you build up reserves rather 
than the Federal Government getting permanently into protecting 
against cataclysms. But on the other hand, if we bring any 
extraneous issue into this, we are lost.
    Mr. Sinnott. Mr. Chairman, can I bring up one issue on that 
that was mentioned earlier that I do not think is extraneous. 
At the hearing I was at yesterday, I was not aware of the fact 
that the Treasury or the Administration, which is of course the 
Treasury proposal, covered property insurance but somehow did 
not include business interruption. That is a very serious 
impediment.
    Senator Gramm. They are very concerned about the potential 
cost of it, the open-ended nature of it, and that is why I am 
not saying I agree with them, but that is why they did it.
    Mr. Sinnott. Business interruption is important and I can 
give you a list of corporations that do not purchase it. There 
are some very large corporations that do not purchase this 
coverage.
    Senator Dodd. Here is the problem you get into with that. 
We talked about it. There is an easier one. Where the car 
service, because it serves a particular industry that was hit, 
it goes out of business because it does not have the capital to 
sustain it. The other business interruption is where some of us 
on the plane have some place to go and sign a contract. Then 
you get into that business interruption. You have a broad 
definition of that and boy, it becomes a nightmare.
    Mr. Sinnott. I agree but I think that the definitions are 
fair under the policy. There is an insurance policy with terms 
and conditions and that coverage has been there for as long as 
I have been around, and it is adjustable. So I do not know why, 
if the insurance industry has been able to deal with that, via 
it's accounting, the Government could not deal with it too. It 
would create a serious defect to excuse business interruption.
    Senator Dodd. It is a challenge, just by the way----
    Chairman Sarbanes. Actually, you are making a very 
important point.
    Senator Gramm. If you can narrow it, you can make the 
point, but you are going to have to do that.
    Chairman Sarbanes. If you leave it out, then you have left 
out an important aspect of the coverage, or leave it out 
altogether.
    Senator Dodd. Let me ask you two other quick questions. We 
are talking property and casualty here but you know the 
questions come up about life and health. It seems to me I do 
not know how you are going to avoid particularly the health 
area, the life. There may be some other argument you can make, 
but the health insurance issues are going to be hard to exclude 
from this calculation. That is one question.
    The second, how do you define an act of war as it is 
usually defined and terrorism. When does an act of terrorism 
become an act of war or not an act of war? Do you think we can 
draw that distinction well enough?
    Mr. Sinnott. It is most of the definition. When you have an 
agent acting in concert with a government, a foreign 
government, in other words, acting at the direction of that 
government, that can be construed as a war risk rather than a 
terrorist risk. On the other hand, in most cases, it is up to 
the government. The government is the one who really declares 
whether a state of war exists.
    Chairman Sarbanes. We have another panel. Unless there is 
anyone who has a question, this has been an extremely helpful 
panel. And we really appreciate your coming. Thank you.
    If the other panel will come forward.
    [Pause.]
    Chairman Sarbanes. We are very pleased to have this panel. 
I know we held you a bit but you can tell we were having a 
pretty interesting and helpful session. We will just go 
straight across the panel. Mr. Donohue, it is nice to see you 
again. We are pleased to have you back with us and we will be 
very happy to hear from you.

                 STATEMENT OF THOMAS J. DONOHUE

          PRESIDENT AND CEO, U.S. CHAMBER OF COMMERCE

    Mr. Donohue. Thank you, Senator. I am here because the 
American consumers and businesses require the financial 
security provided by terrorism insurance to get the economy 
moving again. I am not an expert in insurance the way many of 
you are, but I do understand the challenges facing American 
businesses.
    The problem is the recent events are making adequate 
terrorism insurance hard to come by, and the Government 
temporarily needs to be part of the solution in whichever way 
you think is appropriate. September 11 will result in the 
largest one day insured loss in U.S. history. My understanding 
is the industry will lose $30 to $60 billion in claims, easily 
surpassing the previous record of $30 billion from Hurricane 
Andrew.
    And, without adding any of my other views about the role of 
the class action and trial lawyers, let me say that depending 
on the activities of the Government, some of which have been 
very positive in locating where these matters will be resolved 
and who gets involved in it, that number could be significantly 
higher, and it is a matter to be concerned about, but I am sure 
not resolved in this legislation.
    The insurance industry is committed to meeting its 
obligations and I think they were very forthcoming. The 
Administration was talking about war. These people walked in 
and said we are going to pay our bills. No one was asking the 
Government to bail out the industry, or to take care of its 
established obligations.
    The problem, however, is in the wake of our events of 
September 11, insurers and reinsurers feel compelled, as you 
have heard, to reduce terrorism coverage or not to offer it at 
all, and that is where you get the complication. If you do not 
have it, whose crawling all over your circumstances? And they 
are bankers and they are investors and they are partners and 
everyone else that wants to know what happened if I put my 
money on the line and we either have an activity or we create 
one, how are we going to be sure that if there is an overt act 
of terrorism that we are going to be paid?
    This market disruption caused by a lack of terrorism 
insurance coverage, if it is not provided, could have deep and 
potentially devastating effects. Let me list them quickly. 
First, businesses that cannot get the coverage may have to cut 
back their operations or stop what they are doing in a 
particular business area; trucking firms, railroads, airlines, 
ships, may all be compelled to say, I am not going to carry 
this, I am not going to go there, I am going to limit my 
business activities to protect my interests or to meet the 
requirements of my bank or my other financial partners.
    Second, the lack of such coverage could prevent many 
businesses from obtaining financing. Or it could accelerate in 
what happens with existing financing, in that people are going 
to come to them and say, okay, you don't have the insurance, 
you have to pay me in a certain amount of time, or I have to 
increase your costs, or I am going to close down your line, and 
this is a real serious problem. A lot of loans require evidence 
of terrorism insurance. If you do not have it, the loan is not 
a performing loan.
    Finally, businesses that are left with no choice but to 
self-insure against this risk are going to have to really think 
very hard. They are going to find it very difficult. But I want 
to pass a thought on to the Committee. Let us assume we do not 
do this. Let us assume people go bear or people deal with all 
these issues. If we have another major terrorist incident, I 
mean something of the magnitude we have had, you are going to 
pay for it anyway.
    It is very clear that if we are sitting here a year from 
now and some terrible, horrific thing happens, and the people 
sitting up and down this table say, every single one of the 
major casualty insurance companies in this country are going to 
go bankrupt, you are going to take care of it. So what you are 
really doing is like the guy with the oil filter. You are going 
to cover me now or you are going to cover me later.
    Senator Gramm. You are buying insurance.
    [Laughter.]
    Mr. Donohue. You are buying insurance and what you are 
doing is you are keeping the private sector in this right up to 
their necks about as far as they can go, so the water does not 
get where they are drowning. And what this is, and by the way, 
I am a private sector guy, and I am opposed to creating some 
massive, new Federal deal that covers this thing for now and 
forever. What we are talking about is a bridge and we would 
better make it a bridge that damn well finds a way to get to 
the other end of it, or as Senator Dodd said, and you said as 
well, Senator Gramm, we are going to be adding more and more 
ornaments to this Christmas tree in a big hurry.
    Anyway, I came up here with a very simple message. I am not 
an expert on the insurance issue and not an advocate for one 
solution or the other, other than it ought to be as much 
private as we can so that the private sector does all of the 
background work, carries all of the administrative work; we do 
not need another Government agency. We need the Government to 
insure itself from what it is eventually going to do if it has 
to.
    And I want to congratulate the Committee. It has been 
extraordinary for me in the last couple of weeks to see how 
people have said, wait a minute, we have a political agenda, 
but let us sit down and figure out how we are going to handle 
these things. I just came back, for just a half a second, I 
just came back from the APEC meetings in China, and I was with 
business leaders and government leaders all around the country 
and around the world. It is a very simple thing over there. 
Everybody figured out they made a big mistake. Those guys just 
got their act together, they are all playing the same music, 
they are walking the same step, and I give you great credit for 
what you are doing.
    But I will tell you this is something else you have to do 
and you need to find a way to do it so that it is done in the 
private sector. You take the least amount of risk, but you 
understand if you do not do it, you are going to do it anyway.
    Thank you very much.
    Chairman Sarbanes. Mr. O'Brien.
    Senator Dodd. We have Donohue, O'Brien, and Knorr. Are you 
Irish?
    Chairman Sarbanes. He is from the City of Chicago.
    Senator Dodd. It sounds like a Dublin law firm up there.
    [Laughter.]

                 STATEMENT OF THOMAS J. O'BRIEN

              SENIOR VICE PRESIDENT OF FINANCE AND

              CHIEF FINANCIAL OFFICER, LCOR, INC.

                          REPRESENTING

                   THE REAL ESTATE ROUNDTABLE

    Mr. O'Brien. Thank you, Mr. Chairman. My name is Tom 
O'Brien. I am Chief Financial Officer of LCOR Inc. As such I am 
responsible for companywide oversight of LCOR's finances, risk 
management and insurance activities which includes the $700 
million U.S. Patent and Trademark Office's new headquarters in 
Alexandria, Virginia; the JFK Airport terminal port facility in 
New York, a $1.2 billion airport terminal developed and 
operated by a private consortium, and various other offices and 
multifamily homes located throughout the country but primarily 
from New York to Washington.
    I am what Mr. Sinnott earlier referred to as an insurance 
consumer. LCOR is a national real estate development, 
management company. We specialize in structuring and 
implementing public, private development. We have completed 
projects in 15 States and the District of Columbia including 
one for 16 million square feet of space and 18,000 residential 
units.
    The company has completed developments or has under 
construction projects totaling $4.4 billion and over $1.6 
trillion in pre-
development. LCOR is and has been involved in some of the 
Nation's largest most complex and most creative developments. 
We are currently active throughout the United States as well as 
Pennsylvania, where we are headquartered. I feel well-
represented by the Senators on this Committee based on that.
    But I am here today as a longstanding member of the Real 
Estate Roundtable and on behalf of a number of real estate 
agencies and trade groups that are submitting to this Committee 
written testimony. As many of you are aware, the tragic events 
of September 11 triggered the withdrawal of virtually all new 
insurance on property and casualty. This is caused by the 
insurance industry's inability to predict future man-made 
catastrophic insurance losses. This will be increasingly 
apparent throughout the industry on January 1 when 
approximately 70 percent of the policies are up for renewal.
    I am personally involved in transactions of more than $2 
billion that have been impacted by the eliminating of terrorism 
coverage. By way of example, since September 11, our JFK 
Terminal Four Project has already had its liability coverage 
for terrorism revoked. We are told that we will lose our 
properties' terrorism coverage and that our current policy 
limit will be pushed upward 50 percent. Our premiums will be 
doubling and our revenues have been drastically affected due to 
reduced capacity in volume.
    As CFO of a commercial and residential real estate 
development and a property owner, I know from my 20 years of 
experience that it is not possible to buy, sell, or finance a 
property unless it is adequately covered by insurance. A 
significant percentage of privately owned properties are open 
to the public including shopping centers, offices, hotels, and 
they will need to renew their insurance coverage on or before 
January 1. Many of these owners have been advised that the 
policies may not be renewed or that the new policies will 
exclude exposures currently insured, including terrorism. These 
owners have also been advised that they will all likely have to 
absorb significant increases in premiums. They have also been 
advised that there are greatly expanded uninsured exposures due 
to policy exclusions. Without adequate insurance, it would be 
difficult, if not impossible, to develop, operate, or acquire 
properties, refinance loans, and sell commercial mortgaged-
backed securities.
    Since real estate transactions are primarily based on 
prudent risk-taking, the disappearance of coverage for 
terrorism acts will affect the underwriting of real estate and 
other businesses which could severely disrupt the economy. It 
will not only effect real estate owners and lenders, but also 
their tenants, who lease facilities, their employees and 
customers, and lenders and also anyone who rents an apartment 
or buys a new car. I am very concerned about the short- and 
long-term future of the real estate industry, unless the 
Federal Government creates some type of mechanism to help 
provide this coverage.
    The scale of the industry is immense. Estimates are $4.6 
billion of real estate and as the current policies expire, 
there is tremendous uncertainty about the status of debt in 
this sector. Mr. Baker spoke to some of those concerns on the 
banking side. But obviously it goes well beyond that. Before 
September 11, property and general liability policies typically 
covered losses including business interruption costs from 
terrorism and similar acts. However, as other testimony has 
shown, future policies will likely exclude coverage for 
terrorism and sabotage in addition to the current exclusion 
practices of war.
    As Secretary O'Neill and others have stated already, the 
Federal Government needs to help insure the commercial property 
owners and other businesses that cannot continue to obtain 
insurance coverage for losses related to terrorism in the 
future. I must also add that action needs to be taken as soon 
as possible, because there are policies expiring every day and 
new transactions pending which are being heavily impacted by 
the lack of resolution.
    I am not really familiar with the traffic signals, but I 
know red means stop. May I go on?
    Chairman Sarbanes. For a little bit.
    [Laughter.]
    Mr. O'Brien. We have already said that 70 percent of the 
policies terminate on January 1.
    Chairman Sarbanes. The light gets less waivable the more we 
move through.
    Mr. O'Brien. That is fine. I am almost through. I think it 
is key that we talk about some of the necessary characteristics 
of a workable plan. From a real estate perspective, we believe 
they include the following duration. Real estate is a long-
lived asset and is generally financed over a long period of 
time, generally 10 to 30 years. Thus, if a program is created 
of insufficient length that may not be able to provide the 
stability in the long term, so any program created must be of 
sufficient duration to provide reasonable certainty of the 
future availability of this coverage.
    The second point is the definition of terrorism. The line 
between terrorism and acts of war has certainly been blurred 
since September 11. The President, as well as the media, have 
focused on our current war against terrorism. We believe any 
program created must cover an expansive notion of terrorism so 
that future events along the lines of September 11 and similar 
acts are covered, are not excluded from coverage in the future.
    The third point is development of deductibles and limits of 
coverage. The real estate industry is concerned about what 
could be dramatic increases in deductibles to property owners, 
which could be tantamount to no insurance coverage at all. And 
accordingly, any program must carefully apportion loss exposure 
between property owners, lenders, insurers, and the Federal 
Government.
    One last thing in terms of premium cost disclosure. You may 
have heard earlier that property and casualty rates have 
already been predicted to skyrocket prior to the attack on 
America. We believe insurers should be required to separately 
disclose the cost of comparison coverage and impact on the 
overall insurance rates; otherwise it will be impossible for 
insurance consumers to discern the actual increase in the 
policy as a result of the difficulty in writing the terrorism 
coverage versus the increase as a result of normal market 
conditions.
    Finally, our Congress must not fail to act. The real estate 
industry welcomes the opportunity to work with the 
Administration and Congress to achieve a workable solution to 
this immediate problem and help our company get back to its 
core mission of creating better places to live, learn, work, 
and play.
    Thank you for the opportunity.
    Chairman Sarbanes. Thank you very much, Mr. O'Brien. That 
was a helpful statement. I think you actually made a couple of 
important points toward the end. Afterwards, you might consult 
with Mr. Donohue. He is a pro. You notice he came in right on 
the mark.
    [Laughter.]
    Chairman Sarbanes. When the light turned he was right 
there, but he has had a lot of experience in doing this.
    Mr. O'Brien. Yes, Mr. Chairman. This is my first Committee 
meeting, much less appearance, so I apologize.
    Chairman Sarbanes. You did a good job. We appreciate your 
comments. Mr. Knorr, the Chief Financial Officer of the City of 
Chicago. We are very pleased to hear that you want to get this 
perspective. I also have a statement for the record sent to us 
by Marc Morial, the Mayor of New Orleans, who is President of 
the U.S. Conference of Mayors.
    Without objection, we will include that in the record, and 
the Mayor is urging us to take immediate legislative action.
    Chairman Sarbanes. Mr. Knorr.

                  STATEMENT OF WALTER K. KNORR

       CHIEF FINANCIAL OFFICER, CITY OF CHICAGO, ILLINOIS

    Mr. Knorr. Thank you, Mr. Chairman, for inviting me to 
testify today. My name is Walter Knorr. I am the Chief 
Financial Officer of the City of Chicago. I appreciate the 
opportunity to present to the Committee a matter of great 
concern to the City of Chicago, and I am sure to other cities 
throughout America. The price of war and terrorism liability 
insurance, as a result of the tragic acts of September 11, has 
escalated to incredible levels, if available at all. The 
insurance industry is uncertain about the risk of terrorism and 
therefore appears unable to assess and price that risk.
    In Chicago, our insurance carrier recently cancelled our 
war and terrorism liability insurance coverage for Chicago 
O'Hare International Airport and Chicago Midway Airport. Prior 
to September 11, we paid an annual premium of $125,000 for $750 
million of war and terrorism liability coverage. If we want to 
renew our coverage, it will cost us $6,950,000 for $150 million 
of war and terrorism liability coverage. I will repeat those 
figures to you. Our premium has risen from $125,000 to 
$6,950,000. Our coverage has dropped by $600 million. That is a 
premium increase of over 5,000 percent for substantially less 
coverage.
    Putting it another way, the cost of $1,000 of coverage has 
risen from 16 cents to $46.33 per $1,000. This is an 
astronomical increase, almost 29,000 percent. This 
extraordinary cost increase would be passed along primary to 
our tenants at O'Hare and Midway airports, namely the airlines 
operating out of those airports.
    The financial problems of most airlines have been well 
publicized. A cost increase of this magnitude would negate the 
city's efforts to cut costs of airport operations to benefit 
the airlines and keep them viable. It would also undue the 
efforts of this Congress to assist the airlines financially 
during these uncertain times.
    Chicago is not alone in this. We are aware of a number of 
other major airports across the country that have received 
equally exorbitant quotes for war and terrorism liability 
coverage. In addition, the Chicago airports have been warned 
that their premiums for property and liability insurance may 
double, triple, or even quadruple and deductibles will increase 
significantly.
    The problem extends beyond the airports. It includes 
infrastructure. The City of Chicago insures a toll bridge that 
connects Interstate 94 to the Indiana Tollway. Our most recent 
annual premium was $406,000 for $386 million of coverage. In 
mid-September, the city received a nonrenewal notice for this 
bridge with the ominous indication that the insurance carrier 
could not quote a new rate but that the rate will increase by 
more than 30 percent and potentially much higher. One would 
expect insurance costs associated with terrorism to increase 
substantially for many other public and private structures, 
existing buildings, buildings under construction, public 
meeting areas like sports stadiums and convention centers and 
other prominent infrastructure.
    The increased insurance costs will undoubtedly be passed 
along to the tenants and users of these assets. If those costs 
were significant, and I think they could be, they could have an 
extremely negative economic impact. Tenants would have to 
decide whether to pay those higher costs or leave the city and 
take jobs with them.
    The insurance crisis hits major cities the hardest because 
cities would appear to be the most likely targets for terrorist 
attacks. While terrorists may pick out individual targets, the 
attacks are directed at the Nation as a whole, and the risk 
should be spread to the Nation as a whole. In these uncertain 
times, the Federal Government should act as an insurer for 
future terrorist attacks and catastrophic losses. There are two 
proposals before this Committee and the City of Chicago is not 
taking a formal position on the two proposals. The City does 
believe it is imperative that the Federal Government act on the 
insurance problem to provide certainty of insurance at 
reasonable rates, and hopefully mitigate the cost to Government 
and business.
    Thank you again for this opportunity. I will be available 
for questions that you may wish.
    Chairman Sarbanes. Thank you very much for these 
statements. When do these policies whose figures you quoted 
come up for 
renewal?
    Mr. Knorr. We received a 7 day cancellation after September 
11 on war and terrorism. So as I mentioned, I know of nine 
other major airports across the country that are in the process 
of examining these quotes for these levels of coverage to 
substantially reduce levels of coverage. We are all in the same 
position.
    Chairman Sarbanes. Do you have coverage at the moment under 
the old terms?
    Mr. Knorr. Under the old terms.
    Chairman Sarbanes. When do you lose that coverage?
    Mr. Knorr. We lost it with a cancellation so right now we 
are in a position where we will have to rely on sovereign 
immunity or we basically would be in a position to have to 
piggyback onto the war risk insurance that is attached to 
airlines as vendors.
    Chairman Sarbanes. In other words, you are not covered?
    Mr. Knorr. With this terrorism insurance, yes.
    Chairman Sarbanes. They also said you could keep it at 
these figures?
    Mr. Knorr. These are the quotes we have given back in 
exchange for $750 million for $150 million.
    Chairman Sarbanes. So you are examining the implications of 
that?
    Mr. Knorr. I would say so.
    Chairman Sarbanes. Senator Dodd.
    Senator Dodd. I thank you as well. It has been very helpful 
testimony. It makes the case that maybe we should have had you 
on first in a way because this really is an economic issue.
    As someone pointed out earlier, here they come again, this 
crowd, always showing up at the trough taking advantage of 
tragedy on September 11 to raid the Treasury. I do not believe 
that is occurring. I do not believe it occurred in the airline 
industry, but you have heard that from certain quarters.
    What we are talking about here is not providing any 
assistance at all to the insurance industry. What we are trying 
to do is to encourage the industry to stay in the business, to 
see to it they are going to provide the insurance to public and 
private entities around the country so that they can borrow 
money, they can do the things that are necessary for the 
economy to continue to operate. So the testimony here is very 
important so the case can be made.
    I can see already the words they are using, the word 
bailout. I know what a bailout is. I have seen them around 
here. This does not even come close to falling into that 
category. But the mantra has developed somehow, it becomes 
almost a cliche, and I think your testimony about the 
implications here, and I will make the point, I probably did 
not make as well as I would like to, but I get very worried. I 
am very worried about the condition of our economy anyway. When 
you add the events of September 11 and the events of the last 
several weeks, I worry that we are going to be able to 
hopefully sustain the level of public support for what needs to 
be done in order for us to successfully deal with the issue of 
terrorism. That will require a population that is willing to 
support the kind of expenditures and efforts that are going to 
be necessary over a long period of time.
    I believe the President is absolutely correct. This is not 
a conflict that is going to be resolved quickly. You can only 
resolve it if its representatives have the support of their 
people for continuing to invest in that effort. And if you have 
a weakened economy, if you have high unemployment rates, if you 
have people worried about those conditions, it will be harder 
to sustain the kind of effort that will be necessary.
    I suspect that those who are responsible for the attacks on 
September 11 in some small way will count on an eroding public 
support, and the quickest way that happens is a weakening 
economy. So I am not convinced that everything we are going to 
do in this area is right.
    Grover Norquist, who I do not necessarily associate with on 
too many occasions----
    [Laughter.]
    Senator Dodd. ----but he had the best piece of advice I 
have heard given by anybody. He was asked 2 or 3 weeks ago what 
advice he would give a Member of the Senate these days. I 
thought, oh, boy, here it comes. I can just imagine what this 
advice is going to be. And he said, if I were a U.S. Senator, I 
would read every bill. And that is pretty good advice. It is 
good advice at any time anyway, but we are legislating quickly 
here and maybe we ought to be careful about what gets included. 
But I think that this is a very critical element for us to have 
on the table and done. It may not be everything everyone would 
want, but it is a very needed piece in this puzzle or this 
pattern we are putting together here, to try and prosecute 
successfully the war on terrorism but also see to it that our 
own country is going to remain strong.
    I thank you. And, Mr. Chairman, I do not really have any 
specific questions. I just want to thank you for your 
testimony.
    Chairman Sarbanes. Senator Corzine.
    Senator Corzine. I very much appreciate the real world look 
at what the cost of this is and what implications it would have 
for business or the public sector. I would like to ask Mr. 
O'Brien again, because I am troubled by our focus on a limited 
duration program, do you believe that you will have access, do 
you think your industry will have access to credit if we come 
up with a 1 or 2 year program with cancellation clauses and 
other kinds of options that 
insurance carriers undoubtedly will write here. How do you feel 
that is going to impact your ability to finance some of the 
kinds of projects you have talked about?
    Then let me compliment you. I think the concept of making 
sure that the terrorism premium is disclosed so that we are not 
mixing apples and oranges in here is a very insightful and 
responsible point. And then I would love to hear your comments 
on the business interruption issue as well.
    Mr. O'Brien. Thank you, Senator.
    I have had some first-hand discussions this week with 
longer-term lenders and bond underwriters and bond insurers 
because many of our larger public-oriented projects end up 
being in bond financing. And on Monday of this week, I was 
asked that specific question. Okay, talk to me about the next 
12 months, or talk to me then about the next 28 years, because 
that is what I am underwriting. I am agreeing to accept the 
exposure to today's bondholders. This is the underwriter saying 
to me, how do I know that there is going to be availability of 
some product that is going to protect me from this unknown, 
unquantifable risk, and it clearly focuses much more on the 
fact we have a 3 year development cycle. In cases at patent and 
trademark headquarters, we actually fixed the rental rate for 
the Government 2 years ago.
    So 2 years ago, the Government asked for bids, we gave our 
final best offer, we fixed the rental rate. This month or 
probably next month we will hopefully go forward on starting 
construction. Some 3\1/2\ years later, the Government will pay 
the first dollar of rent to us and they will pay rent during 
the next 20 years. Throughout that 5 year period, 2 years back 
and 3 years forward, we are bearing tremendous uncertainty in 
terms of construction costs, interest rates, but now suddenly, 
in the last month-and-a-half, the cost of insurance 
availability and terms has become predominant. And what you 
could say, some might look at it as a mundane area of the 
business in terms of insurance, at least from a real estate 
developer's perspective. Suddenly, it has become front and 
center.
    So I certainly am concerned about a reasonable certainty as 
to future availability. I am not proposing by any means that 
the program would last 20 plus years, but there is certainly a 
need to look beyond the 12 month time horizon. Many of the 
insurers have the luxury of deciding every 12 months whether 
they are going to renew the coverage. But investment decisions 
are made on a much longer period of time, and I cannot look 
back 12 months, 24 months from now, it is too late. So it is 
definitely a concern of ours.
    As far as the premium side, I said we clearly were already 
aware that premiums were rising quite dramatically and Mr. 
Knorr's comments I can share. The percentages may vary but all 
premiums are really skyrocketing, and to the extent there is a 
way to quantify the portion of the increased cost that 
ultimately is passed on to us and the buyers, the insurer does 
not bear the ultimate cost. He is the balance sheet in between 
the loss and the ultimate recipient or beneficiary being us, 
the insurance buyer. So ultimately they are going to pass the 
cost along to us in one form or another, and we would at least 
like to know that it is a fair, calculable sum, so I appreciate 
the question because it did come up in the first panel, and I 
really think it is an important one.
    Senator Dodd. Jon, let me just interrupt. You made this 
point. In your previous life you know how quickly these 
questions do come up. Putting this aside, just going back in 
your earlier incarnation, how quickly these issues arose.
    Senator Corzine. Nobody is going to write a prospectus now 
without the question of terrorism being one of the risk 
characteristics that you have to address. And it is going to, 
it is either addressed because we have insurance and that is 
going to impact the bottom line of the company, so it is going 
to end up impacting stock valuations, or if you do not have 
insurance, then you are going to pay a spread that is 
dramatically broader for getting access and credit, if you can 
get it at all. And by the way, it is just as true for Mr. Knorr 
and the City of Chicago with regard to bridge financing or 
any--I do not mean bridge in the financial context, but between 
Indiana and Illinois. I do not think people get how big a 
problem this is with regard to the financial interlacing, and I 
could not agree with you more. We are going to need to have a 
sustainable economic environment to fight this broader 
terrorism, and if we do not address these kinds of issues, I do 
not want the perfect to be the enemy of the good, but I think 
somehow or another we are not thinking about the duration 
issue.
    Chairman Sarbanes. I think it is an important point. The 
Pool Re approach, which the insurers put together, he knows 
what that problem is. I understand it because you have this 
pool and it can go on. You know, the one in England has gone on 
now for a number of years. The Government's never actually had 
to pay anything.
    Senator Dodd. It is a million dollars. It is a rather very 
small program.
    Senator Corzine. But the Government is the backstop for the 

insurance.
    Senator Dodd. And the actuarial efforts are much easier 
under that scenario.
    Chairman Sarbanes. That approach takes care of Mr. 
O'Brien's problem as I understand it.
    Mr. O'Brien. To the extent I understand it, Mr. Chairman I 
think it really comes back to no one has all the answers but we 
cannot look at this as a 12 month issue or even a 2 month 
issue. I disagree with the statement this morning that if this 
had happened in March it would not be a problem. That is just 
not the real world. It is a problem. That is because the 
industry is really not able to quantify and charge for what is 
an unquantifiable risk.
    Senator you had asked a second question about business 
interruption and it was something that I had given some thought 
to over the last few days. Because, as we have all seen, in New 
York in particular, the recovery and the acts of private and 
Governmental parties have been phenomenal, but on the private 
side, none of that would have been possible without business 
interruption and some of the property coverages that are 
currently in effect.
    If it would happen without any type of terrorism coverage, 
things would just stop because there would be no funds from the 
private sector to do any of the kinds of things like reopen 
some of the neighboring buildings and restore the economy in 
that part of New York City.
    Senator Corzine. Senator Clinton, at a Budget Committee 
hearing this morning, and I wish I had the sheet, I wrote it 
down, but said that the businesses that were interrupted in the 
immediate area were like 300 but if you take south of Canal 
Street, which has been completely interrupted by the process, 
it is over 1,200 and most of that is small business and it is a 
devastating concept to think we leave business interruption out 
of these kind of packages.
    Chairman Sarbanes. Anything else, Jon.
    [No response.]
    Senator Dodd. I think while Jon was asking that question, 
Mr. O'Brien, you had a very clear good example of how this can 
get way out of hand very quickly.
    Mr. O'Brien. Thank you, Senator.
    Chairman Sarbanes. Gentlemen, than you very much. Mr. 
O'Brien, for your first time you made a very substantial 
contribution. We appreciate it very much.
    Mr. Knorr, do not tell the mayor about this Irish problem.
    [Laughter.]
    Chairman Sarbanes. This hearing stands adjourned.
    [Whereupon, at 12:30 p.m., the hearing was adjourned.]
    [Prepared statements and additional material supplied for 
the record follow:]
            PREPARED STATEMENT OF LESLIE M. (BUD) BAKER, JR.
                     Chairman, Wachovia Corporation
                              Representing
                   The Financial Services Roundtable
                            October 25, 2001
    Mr. Chairman and Members of the Committee, thank you for the 
opportunity to testify on this critical matter. My name is Leslie M. 
Baker, Jr., Chairman of the Wachovia Corporation, here on behalf of the 
Financial Services Roundtable, of which I am the Immediate Past 
Chairman. The Financial Services Roundtable is a trade association for 
the Nation's largest integrated financial services companies. Our 100 
members are drawn from the ranks of the banking, insurance, and 
securities companies.
    I am here today to tell you that without full cooperation between 
our Government and America's private industries in support of insurance 
activities there could be major disruption in the marketplace and harm 
to the economy.
    On October 10, 2001, 30 chief executives from Roundtable member 
companies signed a letter to the Congress expressing concern over the 
impending lack of terrorism coverage and urging Congress to act this 
year. It is important to note that 22 of those 30 signatories are 
bankers, including Wachovia. This makes the point further that this is 
not an issue solely about the insurance industry. Mr. Chairman, I ask 
your consent to have the letter entered into the record.
    The President of the United States, Chairman of the Federal 
Reserve, Secretary of the Treasury and many Members of Congress have 
recognized that our economy needs an economic stimulus package. Without 
Congressional action to provide a Federal backstop for terrorism 
insurance, efforts to provide an economic stimulus could be 
ineffective. This is an issue about the ability of the United States to 
recover from the terrorist attacks of September 11 and the ongoing 
issues of uncertainty, which now weigh upon the economy.
    The possibility of further terrorist acts in the United States 
places uncertainty into many sectors of our economy. Without adequate 
insurance coverage, our Nation could face economic, market, and 
employment disruption. To assist in revitalization and to avoid an 
economic downturn in the United States, the Financial Services 
Roundtable urges this Committee to create some form of Federal 
assistance for insurance losses due to acts of terrorism.
The Nature of the Problem
    Property and casualty insurance coverage is one of those subjects 
that normally attracts little public attention. However, it is a vital 
part of our economy and affects large and small companies in industries 
from banking to real estate, and beyond. Insurers assume risks that 
other parties cannot. For example, insurers shield developers from the 
risks associated with major construction; they protect shippers 
transporting goods and commodities; they cover losses associated with 
homes and cars; they protect employees through workers' compensation 
programs and disability coverage; and they protect businesses from 
legitimate claims arising from business interruption.
    The property and casualty insurance industry has announced that it 
is paying all private sector claims associated with the September 11 
attacks. These costs apparently could reach $50 billion or more. 
Additional acts of terrorism are unpredictable and, as the attack on 
the World Trade Center illustrates, the losses from such attacks can be 
massive. Acts of terrorism are ``human acts'' rather than acts of 
nature. As such, there is no existing actuarial analysis available to 
evaluate such risk. Risk that cannot be priced or managed translates 
into the inability of primary insurers to offer policies or get 
reinsurance. Thus, if primary carriers cannot transfer risk for acts of 
terrorism through the reinsurance market then they cannot sell polices 
that include coverage for such acts. If they are unable to sell polices 
that include terrorism coverage; a lender may be precluded from making 
loans due to increased exposure to uninsured risk.
A Banker's Perspective
    As I stated earlier, without insurance coverage for terrorist acts, 
it will be much more difficult, for bankers to extend or renew 
commercial loans or lines of credit for business purposes, 
construction, or development. To assess the viability of a particular 
loan, a bank must carefully assess the risk of the loan and price it 
commensurate with that risk. Obviously if the risk is too great, the 
bank cannot grant the loan at all. One way borrowers reduce risk to 
themselves and the bank is to acquire insurance protection against a 
number of risks. Purchasing appropriate insurance is standard business 
practice for anyone attempting to obtain financing in the United 
States.
    If the insurance industry cannot offer adequate insurance to a 
borrower or a bank because it cannot properly price or reinsure the 
risk, the bank is faced with a serious risk assessment problem. Is it 
prudent to make a loan to construct a pipeline, or a power plant, or an 
airplane, or a ship, or a large shopping center or office building when 
the potential for the borrower to repay the loan is diminished by 
inadequate insurance coverage? For most banks, the answer will be no. 
Indeed in many cases such a loan, most assuredly, would be considered 
unsound.
    As part of the underwriting process a bank must gain understanding 
of likely sources of repayment in the normal course of events and under 
catastrophic circumstances. A normal part of the underwriting process 
is to make certain that appropriate insurance coverage is available. 
This risk protection is good for the customer as well. In the absence 
of insurance there must be adequate cash reserves in place to provide 
for the retirement of debt. Without insurance, however, such cash 
reserves would lock up capital that our customers need to grow their 
business and create jobs. Either way, a loan may not be approved 
without one of these provisions in place and this is not an acceptable 
outcome for an economy already dangerously slowed.
    Wachovia is one of the five largest commercial real estate lenders 
in the United States. Our company has total commercial exposure of 
approximately $252 billion including real estate and small business 
loans. Specifically, Wachovia's exposure to commercial loans secured by 
real estate is $49 billion and our exposure to small business is $12 
billion. It is important that we continue to serve our customers. In 
particular, I am concerned about the impact on small business customers 
who are already experiencing wide disparity in quoted premiums due to 
insurers' inability to price products consistent with standard 
actuarial analysis. In the case of large or small business, only the 
Federal Government can provide the insurance industry with the 
breathing room it needs to return to a stable, rational market. Without 
a Federal backstop, businesses will have to self-insure putting their 
capital--and ours--at risk. Magnify that potential loss of capital 
across the domestic banking sector to gain an appreciation for the 
dramatic impact a loss of insurance could have on our economy.
    Mr. Chairman, it is impossible to determine if, when or where a 
terrorist might strike, but it is quite clear what the business 
ramifications can be. I am certain, however, that the lack of insurance 
coverage for terrorism will mean fewer loans and that will mean 
constriction of economic activity throughout the country. When a loan 
is not made, the jobs that would have been created to build a plant or 
run an office will not occur.
The Solution
    Mr. Chairman, these economic problems need not arise. With 
appropriate support and assistance from the Federal Government, the 
insurance industry can be in a position to accept the risk associated 
with terrorist attack, and our economy can continue its march to 
recovery. However, something must be done immediately before 
reinsurance contracts expire at the end of the year.
    The Financial Services Roundtable is familiar with the various 
proposals that have been developed. As an organization, we have 
deliberately not stated a preference for any particular one. There are 
insurance experts in the private and public sector working to develop 
details of a plan that can best address the problem. From my 
perspective, any proposal must pass a simple test: it must return 
certainty to the market. As such, the program must be in place for an 
adequate amount of time, and must give primary insurers a chance to 
understand changes in the marketplace and explore adequate alternatives 
for reinsurance. I am certain, given the close collaboration between 
the Congress, the Administration, and the industries affected we can 
develop a workable solution.
    Thank you Mr. Chairman. I would be pleased to answer any questions.
                               ----------
                 PREPARED STATEMENT OF ROBERT E. VAGLEY
               President, American Insurance Association
                            October 25, 2001
    Chairman Sarbanes, Senator Gramm, and other Members of the 
Committee, my name is Robert E. Vagley, and I am President of the 
American Insurance Association, the leading property and casualty 
insurance trade organization in the United States, representing more 
than 410 insurers that write over $87 billion in premiums each year. 
AIA member companies offer all types of property and casualty 
insurance, including those most impacted by the horrific events of 
September 11: commercial liability, commercial property, and workers' 
compensation. Before I begin my formal remarks, I would like to thank 
you for the outstanding leadership you have shown on this issue, and 
for this opportunity to testify before the Banking Committee at this 
crucial time.
    The tragic events of September 11, 2001, forever changed our 
collective understanding of, and concern about, terrorism on our own 
shores. The scope and nature of those attacks were unprecedented in 
world history. None of us--neither private nor public sector 
interests--had made accommodations for this type of occurrence, because 
such things were simply beyond our conception. Unfortunately, we are 
now presented with a new view of the very real risks and potentially 
infinite costs associated with terrorist acts. The new, post-September 
11 world in which we find ourselves is fundamentally different than 
that which existed before, for Americans in general, and very 
specifically for property/casualty insurers and our customers.
    Today, I would like to address two topics. First, I would like to 
briefly describe how our industry has responded to the tragic events of 
September 11. Then, I would like to share our thoughts on how we can 
make certain that insurers are able to continue meeting the 
expectations and future needs of our policyholders with respect to 
terrorism and the wide range of other risks which we insure.
    Current estimates of total insured losses resulting from the 
September 11 attacks stand at between $30 and $60 billion, although the 
final number will not be known for some time, and could end up being 
much higher. This makes the September 11 attacks, by far, the most 
costly insured event in history. Although no natural disaster or man-
made catastrophe even comes close, for the sake of some reference, I 
would note that Hurricane Andrew, which devastated south Florida in 
1992, caused approximately $19 billion in insured losses, perhaps half 
to one-third of the September 11 losses. Put another way, the September 
11 losses will exceed the entire property/casualty industry's net 
income for the past 3 years (1999, 2000, and 2001). On that single day, 
3 years of industry profits, including investment income, were wiped 
out.
    I want to be very clear about our response to the horrific attack 
on the World Trade Center. Notwithstanding the enormity of this loss, 
the insurance industry has been publicly and steadfastly committed to 
meeting our promises to policyholders affected by the events of 
September 11. We have not attempted to invoke war exclusions, despite 
the militaristic nature of, and rhetoric surrounding, the attacks. We 
are paying our claims quickly and fully. We have received claims in 
excess of $20 billion to date. And, unlike other industries who were 
directly affected by the attacks, we are not asking for any financial 
assistance from legislators or regulators to meet our obligations.
    Recognizing that the American people and our economy will recover 
and move onward, we also are looking ahead. Although the property/
casualty insurance industry can deal with the incredible losses from 
September 11, we are very concerned about what will happen if there are 
additional, large-scale terrorist attacks in the future. It is critical 
that you, as public policymakers, share our recognition that terrorism 
currently presents core challenges to the insurance market that we 
cannot meet.
    The financial capacity of our industry, while sizeable, is limited. 
Unfortunately, the potential harm that terrorists can inflict is both 
totally unpredictable in frequency and unlimited in severity. As Warren 
Buffet, CEO of Berkshire Hathaway, recently stated, ``Terrorism today 
is not at all like terrorism 25 years ago. And now you have something 
where the nature of the risk, the power to inflict damage, has gone up 
a factor of--who knows what--10, 50 . . . you cannot price for that.'' 
Put simply, that which is not quantifiable is not insurable in the 
traditional sense.
    As you probably are aware, more than two-thirds of annual 
reinsurance contracts agreements by which primary insurance companies 
purchase their own insurance to adequately spread the risk of large-
scale losses--are renewed each January 1. Reinsurers already have 
notified primary carriers that they intend to exclude or dramatically 
scale back terrorism coverage in the reinsurance contracts coming up 
for renewal. Although the primary insurance sector of the industry is 
adversely affected by such decisions, we recognize that this may well 
be the reinsurers' only way to protect their own solvency.
    Primary carriers, however, do not have the same flexibility as 
reinsurers with respect to our own products because we are subject to 
tighter regulatory controls. Any terrorism exclusions we might choose 
to introduce must be approved by individual State insurance 
departments. If approved, our customers could find themselves bearing 
100 percent of the risks associated with terrorism. Certainly, the 
repercussions of this are clear. However, if exclusions were not 
approved, primary insurers would be left to shoulder 100 percent of 
future terrorist losses, which we simply cannot afford to do. Our only 
remaining option--one we would prefer not to consider--would be to 
simply withdraw from certain markets, and/or lines of coverage.
    So we face a very difficult challenge: how can we remain solvent, 
and still serve the real needs of our customers for financial 
protection against terrorism? I am proud to say that insurers are 
working hard with you, your colleagues in the House, with the Bush 
Administration, to come up with a public policy solution that will 
allow us to continue providing this much-needed coverage to our 
policyholders.
    We believe that the only course of action is immediate enactment of 
legislation to create a Federal financial backstop for losses that 
result from future terrorist attacks. This backstop could be temporary, 
existing only for as long as it is needed. The legislation must be 
enacted before Congress recesses for the year, since so many 
reinsurance contracts which cover this risk will expire on January 1.
    The legislation we are seeking is not, repeat not, a ``bailout'' 
for the insurance industry. In fact, the primary beneficiaries of such 
legislation would be our customers, and the U.S. economy. Ultimately, 
the costs of risk must be borne by the policyholders who seek 
protection through insurance. Given the unprecedented nature of the 
terrorism threat, the best way for this to be done is through a public/
private partnership that allows us to service the coverage needs of our 
policyholders while remaining financially strong enough to pay all 
potential claims, whether from terrorism acts or the other ordinary and 
extraordinary events that affect our business.
    The goal of needed legislation is to ensure that adequate insurance 
coverage remains available to American businesses. Federal Reserve 
Chairman Alan Greenspan recognized this when he testified before 
Congress last week, coming to what he termed the ``very unusual 
conclusion that the viability of free markets may, on occasion, when 
you are dealing with a degree of violence, require that the costs of 
insurance are basically reinsured by the taxpayer, as indeed they are, 
for example, in Great Britain and in Israel and in other countries 
which have run into problems quite similar to ours.''
    There are a number of ways in which this could be done. One is the 
British-style reinsurance pool concept, and another is the quota share 
approach recently suggested by the Administration. A third would 
involve some industry-wide deductible or retention. We are not wedded 
to the details of any particular proposal; not even our own. However, 
in order for any legislative plan to be successful in averting the 
looming economic crisis, it must be drafted in a way that improves 
predictability, stabilizes the market, and preserves insurer solvency.
    No proposal can make the risk of terrorism go away, nor can it make 
the cost of insurance against terrorism risk go away. However, the 
right legislation can provide a way for the public and private sectors, 
on a short-term basis, to comanage this risk--a risk whose dimensions 
changed fundamentally and exponentially on September 11.
    What must be in the legislation from our perspective to make it 
workable? First, rather than 51 possible separate definitions of 
``terrorist act,'' there must be a uniform national definition that 
will constitute the terrorism coverage provided by insurance policies 
all across America. A broad national definition of terrorism is 
essential to avoid nonconcurrence of coverages among primary insurers, 
reinsurers, and the Federal backstop. Such uniformity cannot be 
achieved if States retain the authority to approve or disapprove policy 
forms in this narrow area.
    Second, insurers must be able to quickly include the price for 
terrorism coverage in their insurance policies, rather than be required 
to go to every State insurance regulator and seek that regulator's 
approval for the terrorism rate in every property/casualty line. Even 
with a Federal terrorism reinsurance program that provides a partial 
backstop, individual insurers' retention for terrorism risk will be 
expensive, given the huge uncertainties and potentially large losses we 
collectively face as a Nation. States cannot take the attitude that 
``terrorism cannot happen in our particular backyard,'' and therefore 
suppress rates. Mindful of the general prerogatives of State insurance 
regulators in the rate-setting arena, there must be language in place 
that preserves rate review by the appropriate State regulator, but does 
not subject the rates to any review or approval prior to or in 
connection with the timely introduction of those rates into the 
marketplace.
    Third, we recognize that any Federal terrorism reinsurance program 
will include a number of important details with respect to the 
mechanics of reimbursement and other issues. These details must be 
drafted and implemented in a way that is workable for insurance 
companies and our regulators.
    We understand that, in all likelihood, any new risk-sharing 
mechanism for terrorism coverage will include some significant 
retention of future losses by private insurers. On that point, I would 
like to note that the more risk insurers are forced to retain, the less 
stability there will be in the marketplace. Also, the higher the 
retention, the higher prices will have to be.
    Terrorism has become uninsurable in the private marketplace as 
currently structured. Period. Appreciating that an immediate, stopgap 
solution may be somewhat imperfect, we expect that dislocations will 
still occur as insurers cautiously re-enter the marketplace. It is our 
hope that, with time and experience, we will be able to craft longer-
term, more complete solutions that avoid such disruptions.
    In the absence of Federal legislation to prevent the complete 
collapse of the commercial insurance market, entire sectors of the U.S. 
economy could be left wholly exposed and unable to continue the normal 
course of business. I urge you to act quickly and decisively to ensure 
that all businesses are able to obtain much-needed protection against 
future losses.
    I thank you for your attention and look forward to responding to 
your questions.
                               ----------
                PREPARED STATEMENT OF RONALD E. FERGUSON
                    Chairman, General Re Corporation
                              Representing
                 The Reissurance Association of America
                            October 25, 2001
    I am one of the 2,400,000 people that work in the American 
insurance industry--life and health, property, and casualty--day in and 
day out. I am proud of our industry. I am proud of the role we play in 
our society and in our economy. I am proud of our team, the 2,400,000 
people who are working hard, along with every other American, to get 
this great country back on its feet. And I am proud of the way we have 
stepped up to the losses of September 11 without complaint.
    Our sympathy and condolences go to the families and friends of all 
who have suffered tragic losses in the September 11 terrorist attacks 
on our country. We also express our deep gratitude and respect for the 
courageous emergency services, military personnel, and volunteers for 
their heroic efforts in this time of national pain.
    I might add that for a lot of us in the insurance industry this is 
not just about business, it is personal. We lost a lot of friends. 
People who worked in the insurance industry accounted for at least 490 
of those killed in the World Trade Center. My family was fortunate--our 
son-in-law was among those who escaped unharmed.
    General Re, a wholly owned subsidiary of Berkshire Hathaway Inc., 
is among the four largest reinsurers in the world, and a market leader 
in the United States. While General Re is also in the life reinsurance 
business, I am here today to talk mainly about the property and 
casualty insurance and reinsurance business.
    Let me first say that I believe that the U.S. insurance and 
reinsurance industry will be able to meet its policy and contract 
obligations, and to pay the losses arising out of the September 11 
terrorist attacks. Insurers and reinsurers do not need a bailout for 
those losses from the Federal Government, and are not asking for one.
    We all know that the terrorist attacks of September 11, 2001 
resulted in unprecedented losses of life, personal injury, and property 
damage. It is difficult to estimate the total insured losses that the 
U.S. property and casualty insurance and reinsurance industry will 
ultimately pay as a result of those terrorist attacks. In addition to 
the normal problems involved in estimating large or catastrophic 
losses, in this case there may be liability issues that may take years 
to fully resolve.
    Some recent analysts' reports have suggested that $25 billion to 
$40 billion is a reasonable range of estimated total insured losses 
(property, casualty, life, and health) from the September 11 terrorist 
attacks. Some analysts have even suggested that the total insured 
losses could exceed the range of numbers I just mentioned. My own view 
is that total insured losses (property, casualty, life, and health) 
will be at the high end of the $25 billion to $40 billion range.
    Before September 11 the threat of terrorism within our borders 
seemed remote. Because of that, no insurance or reinsurance premiums 
were collected for terrorism coverages, and no assets or reserves were 
allocated to terrorism exposures. That means that the September 11 
terrorism losses must be paid from the industry's capital account. The 
total capital and surplus of the U.S. property and casualty insurance 
and reinsurance industry at June 30, 2001--including both personal 
lines and commercial lines writers was $298 billion. That figure 
includes $26.6 billion of capital in separately capitalized U.S. 
domestic professional reinsurers. That total industry capital consists 
of required regulatory risk-based capital, as well as the additional 
capital needed to support operating and investment risks and to meet 
the reasonable expectations of policyholders and claimants, rating 
agencies, stockholders, and others.
    The exposure to loss from the September 11 terrorist attacks is not 
spread evenly across the total insurance industry capital base. The 
great bulk of those losses will fall on the capital base of the 
commercial lines insurers and reinsurers.
    One way of looking at the commercial lines capital base is set out 
in Exhibit A. It shows that--after subtracting personal lines capital, 
the Berkshire Hathaway capital that is not allocated to the affected 
lines, and the pre-September 11 third quarter declines in common stock 
values--the affected property and casualty commercial lines insurers 
and reinsurers (U.S. and non-U.S.) had a September 10 estimated 
combined total capital base of $126 billion. That $126 billion capital 
base has now been reduced by $25 billion to $40 billion of losses--pre-
tax and gross of nondomestic reinsurance.
    Tillinghast, in a just-released study for the American Insurance 
Association, noted that the September 11 losses might rest on an even 
smaller capital base--perhaps $80 billion to $100 billion.
    Three things stand out as being very clear to me:

    First, the commercial lines capital base can obviously fund a total 
September 11 insured loss of $25 billion to $40 billion--or an even 
larger loss from that event.
    Second, many actuarial and underwriting principles and practices 
will have to change. While not a complete list, here are five things 
that will change:

 We will have new and different notions about the size, shape, 
    and trends of insured losses and the required risk loads
 Most lines of business will require a greater capital 
    allocation
 Risk-based capital standards will be revised by regulators and 
    rating agencies to incorporate terrorism risk
 The cost of capital for the insurance business will, other 
    things being equal, 
    go up
 We need to rethink risk diversification or its opposite, the 
    correlation of risk

    And there will be other actuarial and underwriting changes.
    Third, the commercial lines capital base cannot take the hit from 
another sizeable terrorist event without seriously compromising the 
ability of the property and casualty commercial lines industry to meet 
its commitments for losses arising from other underwriting and balance 
sheet risks.
    The simple fact is that, on its own, the U.S. insurance and 
reinsurance industry cannot afford to take on the potentially unlimited 
exposure to loss arising from insuring against terrorist acts. The 
commercial lines capital base I have described, while able to absorb 
the losses from the September 11 attacks, simply will not be able to 
sustain multiple events like those attacks. No one at present can 
reasonably predict either the number or scale of future terrorist 
attacks we might face before our war on terrorism is won.
    We support and applaud the steps that the Federal Government is 
taking to combat terrorism. But until those efforts have borne the 
fruit of significant reduction in the potential for terrorist attacks, 
it is close to impossible for many insurers and reinsurers to 
responsibly underwrite or assume terrorism risk. We simply cannot 
evaluate the frequency and severity of terrorism losses using 
traditional underwriting and actuarial techniques. There are no models 
that would let us price the risk with confidence, and the consequence 
of error is ruin. That is why as an industry we need to explore 
alternative ways to cover losses arising from terrorism.
    The September 24, 2001 edition of The Wall Street Journal featured 
this quote from Warren Buffett, Berkshire's Chairman:

          I think in the future, the Government is going to have to be 
        the ultimate insurer for acts of terrorism . . . An industry 
        with very large, but finite, resources is not equipped to 
        handle infinite losses.

    In some very important ways, insurance is the grease that 
lubricates the American economic machine. Insurance and reinsurance 
coverage for terrorism risks is necessary for our economic recovery--so 
that lenders will lend, and builders will build, and employers will 
hire. It is that simple.
    Going forward, we need to find a way to provide insurance against 
terrorist acts that assures both the continued financial viability of 
the U.S. insurance and reinsurance industry, and the continued 
availability and affordability of the wide range of products and 
services provided by that industry.
    In a rare--if not unique--show of unity, the property and casualty 
insurance and reinsurance industries universally agree that the best 
way to do that is to have the Federal Government act as the ``reinsurer 
of last resort'' for terrorism insurance and reinsurance coverage, 
similar to the plan used in the United Kingdom.
    Federal Reserve Chairman Alan Greenspan appears to agree. On 
October 17, 2001, he said:

          What hostile environments do is induce people to withdraw, to 
        disengage, to pull back. It is quite conceivable you could get 
        a level of general hostility that would make viable market 
        functioning very difficult, . . . I can conceive of situations 
        [where] the premiums that would be necessary to enable a 
        private insurance company to insure against all those risks and 
        still get a rate of return on their capital would be so large 
        as to inhibit people from actually taking out that insurance, . 
        . .

          Therefore you are led to what is an unusual conclusion that 
        the viability of free markets on unusual occasions, when you 
        are dealing with violence, . . . [that it is necessary that] 
        the costs of insurance are reinsured by the taxpayers, . . .

          Free markets and Government reinsurance, in this very unusual 
        circumstance they are indeed compatible . . .

          (Source: Bloomberg)

    It is increasingly clear that State regulators, the Administration, 
Members of Congress, and a broad swath of Americans and American 
businesses also agree that we need a solution.
    All of these interests may not currently agree on the right way to 
structure that Federal reinsurer role--we have all heard the several 
proposals that have been advanced. But there is nearly universal 
agreement on the fact that this is a significant and urgent problem 
that needs to be solved before Congress recesses.
    While the size and scale of the September 11 terrorist attacks are 
unprecedented, there are precedents for Government involvement--here 
and abroad--in the solution of temporary insurance market disruptions. 
The Federal Government ran an insurance program during World War II. 
FAIR plans were developed to deal with insurance scarcity in the wake 
of the 1960's urban riots. More recently, the United Kingdom and other 
countries have developed government-backed solutions to terrorism 
insurance.
    When the need for these kinds of programs abates, they tend to fade 
away. When we are successful in our war against terrorism, we fully 
expect that any Federal terrorism insurance solution also fade away as 
normal market solutions return.
    We are eager to work with this Committee, other Members of 
Congress, the Administration, State insurance regulators, and others to 
find a solution that makes sense for the country and for the faltering 
economy, which badly needs an injection of confidence. The solution 
must also make sense for frustrated and injured policyholders and 
claimants, for the insurance industry and its regulators, and for you. 
Insurance is, after all, a critical part of the central nervous system 
of this economy and this society.
    We are not looking for a bailout for the insured losses flowing 
from the tragic events of September 11. We are looking for a way 
forward to serve our clients and fulfill our role in the economy.
    I am reminded of a quote from Winston Spencer Churchill, one of my 
personal heroes. Slightly more than 60 years ago, as Britain was 
engaged in the early stages of World War II, Churchill said, ``Give us 
the tools. We will do the job.''
    As we face a different kind of war, and as we find the way forward 
for the insurance industry, I could not possibly say it any better to 
you and to the Congress: give us the tools.
    I am grateful for the opportunity to speak to you today, and would 
be pleased to answer any questions you may have.


                               ----------
                 PREPARED STATEMENT OF JOHN T. SINNOTT
                     Chairman and CEO, Marsh, Inc.
                              Representing
              The Council of Insurance Agents and Brokers
                            October 25, 2001
    Mr. Chairman and Members of the Committee, I am John T. Sinnott, 
Chairman and CEO of Marsh, Inc, headquartered in New York City. Marsh 
is the world's largest risk management and insurance brokerage firm. We 
have 35,000 employees and serve clients in over 100 countries around 
the world. We also serve virtually all of the major insurance firms 
with reinsurance broking and related services through our Guy Carpenter 
unit. My testimony is on behalf of my firm as well as the member firms 
of the Council of Insurance Agents and Brokers.
    I would like to thank you, Mr. Chairman, for giving me this 
opportunity to testify today on the topic of burgeoning terror 
insurance availability crisis in the wake of the September 11 attacks. 
While it has been said many times before, I think it bears repeating 
that the events of that day have changed the United States, and that 
life and business as we once knew it will never be the same. The events 
of that day were singularly devastating on one industry--the financial 
services industry--not only in business terms, but also in human terms.
    The World Trade Center housed several companies from the banking, 
securities, and insurance industries that must now deal not only with 
the new business challenges facing them as a result of the attacks but 
also with the loss of colleagues and employees. Within the insurance 
industry, the brokerage community was hit particularly hard. Marsh 
maintained offices in both of the World Trade Center towers and the 
space that we occupied in the North Tower comprised the floors directly 
struck by the first aircraft. No one in those offices at the time 
escaped. In fact, of the 1,900 members of the Marsh & McLennan 
Companies working in both towers, and who were visiting that day, 294 
were lost. Another colleague was a passenger aboard one of the 
aircraft. The world's second largest brokerage firm, Aon, also had a 
large presence in Tower 2. They lost 200 of their colleagues. While our 
first response was to focus on our people and the families of those 
lost, we also realized that we had to begin the job of our affected 
clients in resuming their usual business operations.
    The events of September 11 have changed the landscape of commercial 
insurance in a way that I have not seen in my 36 years in the business. 
To be sure, there have been trying times in the past--the liability 
crisis in the mid-1980's, the property catastrophe coverage problems in 
the early 1990's following Hurricane Andrew, to name a couple. Marsh 
rose to the occasion during both those crises to help our clients 
secure the coverage that they needed to adequately protect their 
businesses. This is a function that is quite common in the brokerage 
community--not merely selling insurance products, but identifying 
client needs and developing new and innovative products or programs to 
address coverage shortfalls and to make our clients more successful.
    In response to the mid-1980's liability crisis, Marsh played a 
leading role in the creation of the insurance and reinsurance companies 
ACE Limited in 1985 and XL Capital in 1986. These companies were formed 
to provide excess liability and directors' and officers' liability 
coverages at a time when the market could not provide the necessary 
capacity. These companies were very successful in providing much-needed 
market capacity. They exist as major insurers today. Similarly, Marsh 
played a role in the creation of Mid Ocean Limited during the property 
catastrophe reinsurance crisis following Hurricane Andrew in 1992. This 
company has also done very well in meeting the needs voiced by our 
clients.
    It was in this same spirit of responding to customer needs that MMC 
Capital, our sister company, recently announced the formation of AXIS 
Specialty Limited, a new insurance and reinsurance company formed to 
provide capacity needed in the wake of the September 11 attacks. AXIS 
has an initial capitalization in excess of $1 billion, and will begin 
underwriting later on this quarter.
    Our firm is proud to be able to continue our tradition of 
responding to supply and demand imbalances in the insurance and 
reinsurance markets. But I must tell you in all candor that what your 
Committee heard has been hearing over the past 3 weeks is true--there 
is an immediate crisis that demands your attention. In the current 
unique, and hopefully short-term, environment of uncertainty, the 
private sector alone will not be able to provide the insurance capacity 
America's businesses need to conduct their operations. Government 
involvement is needed until the environment becomes secure and returns 
to a state of more normalcy.
    The problem with what happened on September 11 is that it presented 
a risk that no one had could conceive would happen. When the buildings 
were built, loss scenarios did contemplate the impact of one Boeing 
707, the largest commercial aircraft at the time, however the idea of 
two, fully fueled 767's hitting both towers was unimaginable. Thus, we 
arrive at the problem presented by terrorism: the magnitude and 
severity of potential future events.
    There has been considerable discussion about the scale of the World 
Trade Center and associated losses of September 11. While it will be 
some time before the total costs of the tragedies are computed, we all 
know that they represent the largest-ever losses in the insurance 
industry, by far. The previous largest insured loss was Hurricane 
Andrew at nearly $20 billion--or less than half of the losses of 
September 11. Some further context--the most recent catastrophic losses 
for the insurance industry--including Hurricane's Andrew and Hugo, the 
Northridge and Kobe earthquakes and the Lothar and Martin windstorms in 
Europe--totaled $53 billion in losses. Chances are that the losses 
stemming from the attacks at the World Trade Center will exceed that 
number--perhaps significantly.
    The true cost of these events will not be known for years, because 
some types of insurance, such as business interruption and workers' 
compensation, do not constitute one-time payments but are rather 
ongoing for longer periods of time. While the industry has stated it 
can cover the severity of losses from this event, it is very unclear 
that the industry will be able to meet any frequency of future losses 
that may occur. We are told by Federal authorities to expect 
retaliatory strikes against America and that it is virtually impossible 
to completely shield ourselves from the assaults of those who disregard 
their own lives.
    We have already seen massive and virtually unanimous signs of the 
unwillingness to take on such risks that are unquantifiable. As our 
commercial clients' policies have come up for renewals, we have seen a 
majority of insurers add terrorism exclusions to their policies. Of the 
top 25 property insurers with whom we trade, 17 have stated that 
terrorism exclusions will apply effective immediately and most of the 
others can also be expected to apply exclusions.
    While most insurers will be unwilling to underwrite terrorism risks 
going forward, there may be a few companies who will be willing to take 
on those risks. However, even if they are willing to provide the 
coverage, it is not clear that they will do so at prices which are 
affordable by most businesses. And clearly, such efforts will 
involve adverse selection, in that many businesses that are considered 
most vulnerable probably will not be able to secure coverage at any 
price from any insurer, absent Federal intervention.
    Similarly, there is now a new definition of what a maximum insured 
loss may be. There are not many people who would have ever believed 
that the Twin Towers of the World Trade Center could or would be 
completely destroyed, turned into a pile of dust and rubble, with 
nothing of value left, and with thousands of deaths and injuries. We 
know now that it is possible, and that the concept of a maximum insured 
loss post-September 11 does not in any way resemble the concept we had 
before that date. Threats can come from anywhere in the world, not just 
from one's business partners or from Mother Nature. The scope of risks 
we must plan for has changed as well.
    This change in the perception of risk will have great repercussions 
in the pricing of policies going forward. Before September 11, the 
insurance industry was already experiencing what is known as a ``hard 
market,'' meaning that premium rates were rising. That trend has now 
accelerated significantly. We are now seeing average rate increases in 
the area of 65 percent to 75 percent coupled with dramatically 
increased deductibles, and a contraction of available limits and 
coverages. Some price increases exceed 100 percent.
    It is for this reason that I would urge the Congress to address the 
market contraction that we are facing before it adjourns for this year. 
We are facing a deadline at the end of the year for reinsurance 
contract renewals that will begin to exclude terrorism coverage. If 
insurers cannot cede this risk to a reinsurer, they will be unwilling 
to take it on themselves and will refuse to offer the coverage. That is 
why I am delighted that proposals to address the insurance problems we 
face are being advanced.
    We all are familiar with the two major proposals--the 80/20 plan 
and the pooling arrangement. There are others as well. Until there is a 
cure for the current environment of uncertainty created by the prospect 
of terrorism, the insurance coverage our clients need cannot be 
obtained from the private sector solely. In this somewhat unique--and 
hopefully short-term environment, it is critical that the public and 
private sectors collaborate. Then, once the environment has stabilized, 
and we achieve a state of greater normalcy in the environment, it 
should be practical for Government involvement to decline and 
ultimately be withdrawn.
    As mentioned above, my firm has been severely affected by the 
events of September 11. The first aircraft directly struck our offices 
in the World Trade Center and we lost 295 members of our corporate 
family. That was the real tragedy and is still with us in our offices 
and hallways.
    We also incurred huge losses of property and equipment. So I speak 
here today from painful personal experience--and perhaps with a deeper 
understanding of what our clients face as they look to an uncertain 
future.
    Mr. Chairman, let me restate that we are on the brink of an 
availability/affordability crisis insurance caused by the terrorist 
events. I commend you for holding this hearing, for your efforts to 
create a solution that restores and strengthens the private 
marketplace, and I urge you to work with your colleagues in Congress 
and the Administration and within our industry to find workable 
answers.
                               ----------
                PREPARED STATEMENT OF THOMAS J. DONOHUE
              President and CEO, U.S. Chamber of Commerce
                            October 25, 2001
    Good morning, Mr. Chairman and Members of the Committee. I am 
Thomas J. Donohue, President and Chief Executive Officer of the U.S. 
Chamber of Commerce and Chief Executive Officer of the U.S. Chamber 
Institute for Legal Reform. The U.S. Chamber is the world's largest 
business federation, representing more than three million businesses 
and professional organizations of every size, in every business sector, 
and in every region of the country. The central mission of the Chamber 
is to zealously represent the interests of the entire business 
community before Congress, the Administration, the independent agencies 
of the Federal Government, and the courts. The mission of the Institute 
for Legal Reform is to reform the Nation's State and Federal civil 
justice systems to make them simpler, fairer, and faster while 
maintaining access to our courts for legitimate lawsuits.
    I welcome this opportunity to testify before you on the urgent need 
for prompt Congressional action to help make sure that insurance 
coverage for terrorism is available. I also ask that my full statement 
be inserted into the record.
    The terrorists who attacked our Nation September 11 deliberately 
struck at the center of U.S. finance and commerce. Congress has acted 
promptly to help address a number of the immediate needs raised by the 
September 11 attacks by passing the Air Transportation Safety and 
System Stabilization Act as well as providing much needed emergency 
funding to help with the immediate recovery. Unfortunately, more work 
is needed to help shore up our economy, and passage of Trade Promotion 
Authority and an adequate economic stimulus package would represent 
significant steps. But even those efforts will be inadequate if 
American business is unable to move forward secure in the knowledge 
that the potential risks associated with future terrorist attacks will 
not cripple them beyond the point of recovery.
    The attacks have had a significant impact on the insurance 
industry. September 11 will result in the largest insured loss in U.S. 
history. It has been estimated that the insurance industry will pay 
between $30 and $58 billion in claims, and some estimates are even 
higher. To put the magnitude of this event in perspective, it easily 
surpasses the $30 billion, without adjusting for inflation, paid for 
claims because of Hurricane Andrew. The insurance industry has 
indicated that it remains committed to meeting its obligations to 
policyholders for the events of September 11. These claims for 
terrorist losses will be paid directly by the primary insurers 
operating in the United States, with a major portion of the costs 
ultimately shared throughout the global insurance and reinsurance 
community.
    The problem, however, is that in the wake of these events, insurers 
and reinsurers are examining how to manage the heightened level of 
terrorism risk they are facing and are reevaluating what coverage, if 
any, they may provide for it. The September 11 attacks fundamentally 
changed assumptions about the scope of risks and losses associated with 
terrorism. It now seems that any commercial enterprise, from Main 
Street-type small businesses to multinational American ``icon'' 
corporations, could become targets of or affected by the next terrorist 
attack on American soil. As a result of the potentially astronomical 
increase in liability, the insurance industry has begun to indicate 
that it cannot cover losses associated with future terrorist attacks.
    A single-day event of the magnitude experienced on September 11 is 
a substantial hit to the capital base of many companies as well as the 
worldwide insurance industry as a whole. While the attack may strain 
many insurance companies, current indications are that the majority of 
companies will be able to meet their obligations. However, in the short 
run, the United States and global reinsurance industry does not have 
the capacity to provide protection against another major incident, or a 
continuing series of incidents. Companies with significant losses 
stemming from the terrorist attack will need to raise fresh capital in 
order to maintain their capacity to insure against all other risks 
covered by their contracts. Uncertainties regarding losses from future 
terrorist attacks will likely make raising fresh capital problematic. 
As a result, because of the unprecedented scope and nature of the 
losses sustained last month and the unpredictability of future 
liabilities, insurance coverage against future acts of terrorism will 
become virtually unobtainable for the vast 
majority of policyholders.
    Major reinsurers have already alerted their clients that they 
intend to sharply reduce or eliminate their coverage for terrorist 
attacks, particularly policies on large commercial risks such as office 
towers, transportation hubs, sports arenas, and the aviation industry. 
The lack of reinsurance would leave primary insurance companies on the 
hook for all of the risk of a terrorist attack, a position they cannot 
assume. This, in turn, will force primary insurers to eliminate the 
availability of such coverage. Therefore, because the majority of 
American businesses traditionally renew their insurance contracts each 
January 1, businesses of all sizes and kinds could be left without 
insurance against terrorist acts.
    What does that mean? If not corrected, this market disruption in 
insurance coverage will have deep, widespread, and potentially 
devastating ripple effects throughout the entire U.S. economy. 
Businesses that cannot secure full insurance coverage, including 
coverage for terrorist acts, may decide that risks from a lack of 
complete coverage leave them too vulnerable thus forcing them to reduce 
operations that would be considered too likely to be terrorist targets. 
This would result in layoffs and the elimination or decreased 
availability of a variety of products and services. For example, 
without adequate coverage, trucking firms, railroads, airlines, and 
ships may be unable to transport many types of cargo or limit their 
destinations.
    In addition, a lack of terrorism insurance coverage could 
significantly harm the ability of many businesses to obtain financing 
or otherwise buy or sell properties, businesses, or projects. 
Furthermore, it is important to note that this is not only a 
prospective problem. For example, the terms of most loans require 
evidence of adequate insurance. If adequate insurance is no longer 
available, borrowers may find themselves in technical default of their 
loan terms. As a result, lenders would be in the position of 
potentially having to try to find adequate insurance coverage for their 
borrower that may not exist or either accelerating payments under the 
terms of the loan or calling-in the loan in its entirety. They may also 
be forced to cut down on the amount of available credit as they build 
their reserves in the event of additional terrorist attacks. Finally, 
if businesses decide to self-insure the risk of future terrorist 
attacks, they may find it difficult, if not impossible, to attract 
their own reinsurance or even new capital.
    The principle upon which insurance rests is the ability to spread 
risk so that no single person or entity is forced to bear the full 
impact of an economic loss. Without this ability to spread risk, 
individual American businesses cannot afford to take on the potentially 
unlimited exposure to loss arising from uninsured terrorist attacks. 
Without some appropriate partnership between the insurance industry and 
the Federal Government, the looming constriction in the insurance and 
reinsurance markets threatens to inflict serious injury to the U.S. 
economy. This would potentially result in American businesses and 
citizens incurring substantial losses even if we do not suffer a future 
terrorist attack.
    It is critical that the business community, the Administration, and 
Congress come together before the end of this year's Congressional 
session to develop and implement an appropriate Federal financial 
backstop for terrorism exposure. If such a backstop is not created, our 
Nation's economic recovery will be seriously jeopardized. Whatever 
approach is developed, it should support ongoing efforts of the private 
insurance and reinsurance markets to return to their proper role of 
underwriting risks while recognizing a Government backstop may be 
necessary for a period of time.
    The Chamber recognizes that there are a number of ways in which 
this issue could be addressed and we stand ready to work with all of 
the stakeholders to ensure that a workable mechanism is developed so 
that we can avoid a widespread economic crisis and keep American 
businesses in business. I would be happy to answer any questions you 
may have. Thank you.
                               ----------
                PREPARED STATEMENT OF THOMAS J. O'BRIEN
  Senior Vice President of Finance and Chief Financial Officer, LCOR, 
                                  Inc.
                              Representing
                       The Real Estate Roundtable
                            October 25, 2001
    My name is Thomas J. O'Brien, and I am the Senior Vice President of 
Finance and Chief Financial Officer of LCOR. As a member of LCOR's 
Management Committee, I am responsible for the company-wide oversight 
of LCOR's finances, risk management, and insurance activities--
including those of the JFK International Air Terminal LLC--a $1.2 
billion air terminal redevelopment project and its related 
operations.
    LCOR is a national real estate development, asset management, 
investment, and operations management company, specializes in 
structuring and implementing public/private developments. We have 
completed projects in 15 States and the District of Columbia, including 
more than 1.6 million square feet of commercial space and 18,000 
residential units. The company has $4.4 billion in developments 
completed or under construction, and over $1.6 billion in 
predevelopment. As the leader in public/private development, LCOR is, 
or has been, involved in some of the Nation's largest, most complex, 
and creative developments. LCOR's operating offices are in New York 
City, Washington, DC, New Jersey, Dallas, Denver, and Berwyn, 
Pennsylvania, where the company also has its corporate office.
    I am here today as a long-standing member of The Real Estate 
Roundtable and on behalf of a number of real estate organizations and 
trade groups that are separately submitting written testimony.
    The tragic events of September 11 have triggered a withdrawal of 
virtually all commercial property and casualty insurance coverage for 
terrorist damage. While this will become readily apparent throughout 
the economy on January 1, when approximately 70 percent of the policies 
on commercial properties are scheduled for renewal, it is already a 
problem in our market.
    As the CFO of a commercial property owner, I know that it is not 
possible to buy, sell, or finance a commercial building unless it is 
covered by adequate insurance. A significant percentage of owners of 
commercial properties open to the public, including shopping centers, 
offices, and hotels renew their insurance coverage on January 1 each 
year. Many of these owners have been advised that their policies may 
not be renewed or that their new policies will exclude terror/war 
risks.
    Without adequate insurance, it will be difficult, if not 
impossible, to operate or acquire properties, refinance loans, and to 
sell commercial-backed securities. Disappearance of coverage for 
terrorist acts for real estate and other businesses could severely 
disrupt the economy. I am very concerned about the short-term future of 
the real estate industry unless the Federal Government creates some 
type of mechanism that would provide this coverage.
    The scale of the real estate industry is immense--with income-
producing real estate representing an estimated $4.6 trillion--with 
$2.05 trillion in institutional-grade real estate. In the institutional 
real estate market--which includes office, 
retail, hospitality, multifamily, and industrial--there is total equity 
of $372.7 billion--largely supplied by REIT's (39.3 percent) and 
pension fund investors (38.6 percent)--and total debt of $1.67 
billion--with 42 percent held by commercial banks, 14.8 percent held by 
CMBS investors, and life insurance companies holding 13 percent. This 
does not include approximately $6.7 trillion in owned homes (single 
family, condominiums, and co-ops).
    As these policies expire, there is tremendous uncertainty about the 
status of debt to the sector, with some $700 billion in commercial bank 
debt, $350 billion of loans in CMBS, $220 billion of loans held by life 
insurance companies that ran the risk of being in nonmonetary default 
without the availability of terrorist coverage. This lack of coverage 
raises profound liquidity concerns not only on existing loans and the 
institutions that hold them but on the ability of borrowers to secure 
financing going forward.
    Before September 11, property and general liability policies 
covered losses stemming from terrorist acts. But as confirmed by 
insurance industry CEOs' testimony before the House Financial Services 
Committee on September 26, future policies will exclude coverage for 
both terrorist acts and acts of war. Additionally, they stated that 
reinsurance for terrorism is currently unavailable in the marketplace, 
Without reinsurance, there will likely be no primary insurance covering 
terrorist damage. As a result, the real estate and construction 
industries, which account for over a quarter of the Nation's gross 
domestic product, could face severe economic dislocation in the coming 
months if the Federal Government does not immediately address 
insurance-related issues tied to terrorism.
    The Federal Government should play a role to ensure that commercial 
property owners and other businesses can obtain insurance coverage for 
damage from acts of terrorism. It is important to act before these 
policies terminate on January 1 to ensure that insurance coverage for 
terrorist acts is available in the future. Necessary characteristics of 
a workable plan include the following:

        Duration: Because real property is a long-lived fixed asset, it 
        is generally financed over a long term--typically 10-30 year 
        term. Thus, if the program created is of insufficient length, 
        it may not provide sufficient stability in the short term. Any 
        program created must be of sufficient duration to provide 
        financial certainty for these long-term lenders.
        Definition: The line between ``terrorism'' and ``acts of war'' 
        has been blurred significantly since the September 11 attacks 
        on the World Trade Center and the Pentagon. President Bush and 
        news media have been focused on our current ``war against 
        terrorism.'' The real estate industry is concerned that the 
        next 
        incident in this ongoing conflict may be considered an ``act of 
        war'' by the insurance industry and therefore be excluded from 
        coverage. Accordingly, any program created must cover an 
        expansive notion of terrorism so that future events along the 
        lines of September 11 are covered--and are not excluded from 
        coverage in the future as an act of war.
        Deductible: The real estate industry is concerned that a 
        dramatic and unsupportable increase in deductibles to property 
        owners could be tantamount to no insurance coverage at all. For 
        example, if a real estate owner plans to acquire a $10 million 
        property with $3 million of equity and $7 million of debt, an 
        insurance policy with a deductible of $3 million or more, 
        effectively would wipe out the real estate owner's equity and 
        would militate against investment in the property. Accordingly, 
        any program created must carefully consider apportionment of 
        loss exposure among property owner, lender, insurer and the 
        Federal Government.
        Disclosure: With property and casualty insurance rates already 
        skyrocketing prior to the attack on America, insurers should be 
        required to separately disclose the cost of terrorist coverage 
        to avoid any misunderstanding as to the program's impact on 
        overall insurance rates. Otherwise, it would not be possible to 
        discern the actual increase in the policy as a result of the 
        difficulty in writing terrorism and act of war coverage and the 
        result of other issues.

    The Congress must not fail to act. Our industry welcomes the 
opportunity to work with the Administration and Congress to achieve a 
workable solution to this immediate problem this year.
    Thank you for the opportunity to be here today.
                 PREPARED STATEMENT OF WALTER K. KNORR
           Chief Financial Officer, City of Chicago, Illinois
                            October 25, 2001
    Thank you, Mr. Chairman for inviting me to testify today. My name 
is Walter Knorr and I am the Chief Financial Officer of the City of 
Chicago. I appreciate the opportunity to present to the Committee a 
matter of great concern to the City of Chicago and, I am sure, to other 
cities throughout America.
    The cost of war-and-terrorism liability insurance as a result of 
the tragic acts of September 11 has escalated to incredible levels. The 
insurance industry is uncertain about the risk of terrorism, and 
therefore unable to assess and price that risk.
    In Chicago, our insurance carrier recently canceled our war-and-
terrorism liability insurance coverage for Chicago O'Hare International 
Airport and Chicago Midway Airport. Prior to September 11, we paid an 
annual premium of $125,000 for $750 million of war-and-terrorism 
liability coverage. If we want to renew our insurance, it will cost us 
$6.95 million for $150 million of war-and-terrorism liability coverage. 
I will repeat those figures for you. Our premium has risen from 
$125,000 to $6,950,000. Our coverage has dropped by $600 million. That 
is a premium increase of over 5,000 percent for substantially less 
coverage. Expressed another way, the cost of $1,000 of coverage has 
risen from 16 cents to $46.33--an increase of 28,956 percent. This 
extraordinary cost increase would be passed along primarily to our 
tenants at O'Hare and Midway, namely the airlines operating out of 
those two airports. The financial problems of most airlines have been 
well publicized. A cost increase of this magnitude would negate the 
city's efforts to cut the costs of airport operations to benefit the 
airlines and keep them viable. It also would undo the efforts of this 
Congress to assist the airlines financially during these uncertain 
times.
    Chicago is not alone in this. We are aware of a number of other 
major airports across the country that have received equally exorbitant 
quotes for war-and-terrorism liability coverage. In addition, the 
Chicago airports have been warned that their premiums for property and 
liability insurance may double, triple, or even quadruple--and 
deductibles will increase significantly.
    The problem extends beyond airports. The City of Chicago insures a 
toll bridge that connects Interstate 94 to the Indiana Tollway. Our 
most recent annual premium was $406,000 for $386 million of coverage. 
In mid-September the city received a nonrenewal notice for this bridge, 
with the ominous indication that the insurance carrier could not quote 
a new rate, but that the rate will increase by more than 30 percent and 
potentially much higher. One would expect insurance costs associated 
with terrorism to increase substantially for many other public and 
private structures: existing buildings, buildings under construction, 
public meeting areas like sports stadiums and convention centers, and 
other prominent infrastructure. The increased insurance costs would 
undoubtedly be passed along to the tenants and users of the these 
assets. If those costs were significant--and I think they could be--
they could have an extremely negative economic impact. Tenants would 
have to decide whether to pay those higher costs or leave the city and 
take jobs with them.
    The insurance crisis hits major cities the hardest because cities 
would appear to be the most likely targets for terrorist attacks. While 
terrorists may pick out individual targets, the attacks are directed at 
the Nation as a whole and the risk should be spread to the Nation as a 
whole. In these uncertain times, the Federal Government should act as 
an insurer for future terrorist attacks and catastrophic losses.
    There are two proposals before this Committee, and the City of 
Chicago is not taking a position on the two proposals. The city does 
believe it is imperative that the Federal Government act on the 
insurance problem to provide certainty of insurance at reasonable 
rates, and hopefully mitigate the cost to Government and business.
    Thank you again for this opportunity. I will be available for any 
questions you might have.
                               ----------
                 STATEMENT OF STEVE LEHMANN, FCAS, MAAA
                  Vice President for Property/Casualty
                     American Academy of Actuaries
                            October 25, 2001
Introduction
    The American Academy of Actuaries appreciates the opportunity to 
provide comments on issues related to insurance and the threat of 
future terrorist acts. The Academy hopes that these comments will be 
helpful as the Committee considers related proposals.
    The Academy is the nonpartisan public policy organization for the 
actuarial profession and assists policymakers through presentation of 
clear actuarial analysis. For more than 30 years, membership in the 
Academy has been a hallmark of professional quality for U.S. actuaries. 
Academy members are bound by rigorous professional standards for 
conduct, practice and qualification, and discipline.
    The actuarial profession is uniquely qualified to examine issues 
relating to insurance and reinsurance of catastrophes. Academy members 
who practice in the insurance field typically have a broad 
understanding of insurance risk and company 
financial management, and they are well equipped to evaluate 
reinsurance arrangements. Many Academy members also have extensive 
practical experience in evaluating the financial risk associated with 
natural disasters and other catastrophic events and in pricing related 
coverages for the private marketplace.
    Given this expertise, the actuarial perspective is valuable in 
examining the fundamental aspects of insurance and in describing policy 
considerations associated with proposals to address the impact of 
terrorism on the insurance industry.
Defining the Problem
    In the aftermath of September 11, insurers and insureds face a 
significant problem with respect to future coverage of terrorism risk, 
due to both the nature of insurance and the nature of the threat 
involved.
    Insurance is at the foundation of a free market system, because it 
gives entrepreneurs and businesses the freedom to focus their resources 
on the conduct of their business without concern over the magnitude and 
volatility of potential fortuitous losses. Insurers accept that risk as 
long as it is quantifiable and appropriately priced. Where that is not 
possible, insurers become reluctant to accept the risk.
    A dramatic change occurred on September 11, when a new risk of 
terrorism emerged from an event that had never even been imagined by 
insurers or insureds. The risk of terrorism involves prospective losses 
of unknown but potentially very high severity and unknown frequency. 
This makes risk quantification very difficult. Furthermore, it reaches 
beyond first-party property coverage to involve other coverages (such 
as workers' compensation, liability, and business interruption) that 
are also difficult to quantify. Even building a new risk model to 
define the scope of 
potential losses from acts of terrorism will be extremely difficult. 
This difficulty is aggravated by the inapplicability of existing models 
and the total absence of any historical data.
    As a result of the September 11 events, there is enormous strain on 
the entire insurance system. Insurance mechanisms have to bear 
previously existing risks as well as the unknown and unpriced risk 
associated with terrorism. Additionally, though the industry may have 
retained significant surplus following the September 11 attacks, such 
surplus is needed to support all of the risk assumed by insurers for 
all of the lines of business they have written. Given these 
difficulties, in the short term at least, insurers are being driven to 
avoid losses that could occur from acts of terrorism in order to 
preserve their own financial security. From a public policy 
perspective, lack of coverage for such losses is not an acceptable 
outcome.
Private-Sector Solutions
    Because insurance coverage plays such a vital role in our economic 
system, various proposals have emerged to provide some limitation on 
the aggregate risk from terrorism to be borne by the private sector. 
The immediate actuarial problem of pricing this new risk can be 
diminished by limiting the losses that would have to be paid by the 
private insurance market. In considering solutions to the problem, 
considerable discussion has focused on the concept of a terrorism 
reinsurance mechanism, that in turn raises a number of important 
concerns. For example:

 How would such a mechanism be funded? Would it be funded 
    prospectively by premiums charged to the participant insurers, 
    retrospectively by assessments to the participant insurers, or 
    through some combination of these approaches?
 How would liquidity be assured so that funds would be 
    immediately available to pay claims when they occur?
 How would the terrorism trigger be defined so as to preclude 
    coverage disputes between participating insurers?
 Would this mechanism be voluntary or mandatory? Would it be 
    available to noninsurer, risk-assuming entities such as self-
    insured municipality pools?
 Will Governmental protection be available as a backstop above 
    a finite limit of loss?

    Answers to each of these questions and perhaps others will be 
necessary before a pricing model can be developed. Broad-based 
participation by insurers is critical to spreading terrorism risk if a 
private-sector mechanism is adopted. If the mechanism is voluntary, 
there must be adequate incentives to entice insurers to participate. 
Voluntary participation in any mechanism also brings up issues of 
potential adverse selection (that is, only high-risk insurers and 
businesses participate).
    It has been suggested that it would be appropriate for Government 
to provide coverage for terrorism losses above a certain limit. In view 
of the magnitude of potential losses, it is difficult to conceive of 
any effective mechanism that would not have to involve the Federal 
Government, at least in the short term. However, any short-term 
solution will undoubtedly require future modification to reflect an 
increased understanding of the risk involved as well as subsequent 
experience gained in addressing it. All of the proposals currently 
being considered sunset in less than 10 years. A sunset period is 
necessary to provide time for the insurance industry to develop 
adequate risk assessment techniques while providing protection for 
insurers and insureds in the interim. A new mechanism may also be 
needed to address terrorism risk over the long term.
Conclusion
    Some mechanism is needed now to ensure stability of insurance 
coverage. Some level of Government intervention appears to be necessary 
and appropriate in the short term. Over time, the insurance industry 
should be able to develop tools and techniques to help quantify and 
assess the risk of terrorist attacks more effectively.
    Public policymakers evaluating any proposal designed to assist 
insurers in achieving that objective and to protect insureds from the 
threat of terrorism should carefully weigh the following 
considerations:

 Incentives for participation in voluntary mechanisms;
 Potential for adverse selection;
 Funding source and liquidity of mechanism; and
 Level of government involvement in the short term and long 
    term.

    The American Academy of Actuaries is available as a resource to the 
Committee as it seeks to address this important concern.
                               ----------
           STATEMENT OF THE AMERICAN COUNCIL OF LIFE INSURERS
                            October 25, 2001
    The ACLI is the principal trade association for the life insurance 
industry, representing 426 companies, which account for 80 percent of 
the life insurance premiums and 81 percent of annuity considerations in 
the United States among legal reserve life insurance companies. ACLI 
member company assets account for 80 percent the total assets of legal 
reserve life insurance companies. We appreciate the opportunity to 
present this statement to the Committee on Banking, Housing, and Urban 
Affairs on the topic of insurance coverage for terrorist acts.
    As the collateral effects of the attacks of September 11 continue 
to unfold, much attention has been focused on the financial condition 
of the insurance industry. In this regard, the property/casualty 
insurance business will ultimately incur losses estimated at between 
$30 to 50 billion, while the life insurance industry losses will be in 
the $4 to 6 billion range.
    Both segments of the insurance industry have repeatedly sought to 
assure the public and Members of Congress that they have adequate 
resources to cover these losses. However, the threat of additional and 
perhaps more widespread terrorist attacks, with even more devastating 
losses, dictate that Congress examine the capacity of the insurance 
system to respond to such previously unthinkable scenarios. We commend 
the Committee for its timely examination of this critical issue.
    Thus far, the property/casualty industry has been the focus of 
efforts to develop a private sector/Government partnership to 
underwrite the risks associated with expanded terrorist losses. This is 
appropriate as the property/casualty industry has obviously had to 
absorb a much greater impact on its available capital reserves as well 
as a more immediate response from its reinsurers that terrorist 
coverage would be severely limited or unavailable in the future.
    Because the life insurance industry has more than $3.2 trillion in 
assets and processes, on the average, about 10,000 death claims each 
day, the losses of life resulting from the September 11 attacks, while 
tragic, do not pose a threat to the solvency of the life insurance 
industry. However, the potential for continued acts of terrorism to 
result in substantially more significant adverse effects on mortality, 
and by that we mean the potential for mass death and disability on a 
much larger scale than we have previously experienced or imagined, 
gives rise to questions that we believe must be considered by Congress 
as well as the life insurance business. Will there continue to be a 
viable private sector market for life insurance products that cover 
risks of terrorism? Put differently, will life reinsurers continue to 
enter into reinsurance treaties covering catastrophic risks that 
include acts of terrorism? Additionally, if there are realistic 
prospects of an act of terrorism of sufficient magnitude to adversely 
affect the overall solvency of the life insurance business, is there a 
justifiable need for some mechanism to address that situation, and, if 
so, what form might such a mechanism take? The uncertainty surrounding 
these questions suggests a need for the Committee to evaluate the 
potential needs of the life insurance industry, including its 
customers, as part of its current inquiry.
    At this time, we are not seeking the establishment of a mechanism 
similar to those under consideration for property/casualty insurers. 
Indeed, it is not clear at this point that such a mechanism would be 
necessary or useful for life insurers. Nor is there any agreement 
within our industry as to what such a mechanism should look like were 
it deemed to be necessary. We think it is prudent, however, to start 
the process of asking ``what if ?'' and to begin doing it now, before 
events necessitate a last-minute, crisis-driven reaction that might not 
be entirely in the best interests of the life insurance industry or its 
customers.
    In that regard, the ACLI has developed a proposal to create a study 
commission comprised of Government and private sector representatives 
to assess the potential effects on the life insurance industry of 
further terrorist activities. The proposal is designed to be included 
in whatever legislation the Congress develops to address property/
casualty insurance issues. This is not a request for Government 
assistance. It is instead our industry laying down a marker to reflect 
the need to examine this issue thoughtfully, hopefully without the risk 
of being overtaken by events.
    Briefly, the proposal would work as follows. A nine member study 
commission would be appointed to assess: (1) possible steps that could 
be taken to encourage and sustain the private market for life insurance 
products covering death or disability resulting from acts of terrorism 
and the threat of such acts; and (2) possible steps or mechanisms to 
sustain or supplement the ability of life insurers to cover losses due 
to death or disability resulting from acts of terrorism that 
significantly affect mortality experience or jeopardize the solvency of 
the industry as a whole.
    This study commission would be comprised of five representatives 
from Government (two from Treasury, one from Commerce, one from the 
Office of Homeland Security, and one from the ranks of State insurance 
regulators) and four from the private sector (two representing life 
insurers, and two representing life reinsurers). Any affirmative 
recommendations by the study commission would have to have the 
concurrence of at least two-thirds of the commission members to assure 
that such recommendations have at least some support from the life 
insurance business.
    The study commission would have 30 days to organize itself and 
another 90 days to complete its work. The report of the commission 
would be submitted to the President pro tempore of the Senate and the 
Speaker of the House, with a copy to the White House. The legislation 
would direct Congress to give ``prompt and deliberate consideration'' 
to any recommendations for Federal legislative action contained in the 
report. The study commission would be disbanded within 60 days after 
submission of the report.
    To reiterate, by advancing this study commission, the ACLI is 
simply suggesting that the question of how acts of terrorism, or even 
the threat of such acts, will affect the life insurance business is a 
critical matter warranting prompt and thoughtful consideration by both 
the private sector and Government. The events of September 11 have 
unquestionably introduced great uncertainty into the life insurance 
business. This uncertainty involves concerns over the way in which the 
risk of terrorism will be covered in insurance policies, how that risk 
will be quantified, how attendant pricing decisions will be made, and 
whether future events that even a few months ago were unimaginable 
carry with them the potential to overwhelm the solvency of our 
business. Given this uncertainty and the gravity of the issues at 
stake, we believe a study as outlined in the attached draft language is 
an appropriate response at this juncture.














        STATEMENT OF THE INDEPENDENT INSURANCE AGENTS OF AMERICA
                            October 25, 2001
    This testimony is submitted on behalf of the Independent Insurance 
Agents of America (IIAA). IIAA is a nonprofit trade association that 
represents over 300,000 independent insurance agents and brokers and 
their employees nationwide. IIAA's membership is composed of large and 
small businesses that offer consumers a wide array of products in every 
State, city, and town in the country. The independent insurance agent 
and broker industry sells 75 percent of all commercial lines policies 
in the country. In essence, independent agents and brokers write 
coverage for America's businesses, and through this unique prism of 
expertise and for the reasons outlined below, we strongly urge the 
passage of legislation to ensure the availability and affordability of 
essential business insurance products in the aftermath of the horrific 
acts of September 11.
    The terrorist acts of September 11 have had a profound impact upon 
all of us, with the insurance industry being hit particularly hard, 
both physically and financially. IIAA has over 20 agency members in 
Lower Manhattan, including one that was previously located in the South 
Tower of the World Trade Center, and many more had valued customers who 
were located in the complex. In the days and weeks that have followed 
the attacks, countless victims and survivors have begun putting their 
lives back in order, and the insurance industry has played a pivotal 
role in this recovery-and-rebuilding process. We are proud and pleased 
by the manner in which our industry responded to the events of 
September 11, and the best news was that things worked as they were 
intended. The insurance industry has honored its commitment to 
thousands of Americans in their greatest time of need--and the industry 
is proving that it has the resources needed to quickly and fully pay 
claims.
    Although the insurance industry has responded efficiently and 
effectively to these attacks, we must now work to ensure that the 
industry is in a position to respond in similar ways to future 
terrorist attacks. In order to address these new challenges, we will 
need the leadership and assistance of the U.S. Congress and the Bush 
Administration to ensure that appropriate insurance coverage remains 
available. The issue of terrorism reinsurance is so vital to the future 
of American businesses--large and small alike--and to the health of the 
Nation's economy that it needs Washington's immediate attention. The 
time for action is now. Congress and the 
Administration need to address this important national policy issue as 
soon as 
possible.
    The possibility of further terrorist attacks elucidates the need 
for mechanisms to assure the continuing availability of coverage for 
these risks. Although the insurance industry is prudently managed and 
well capitalized, it cannot and should not be expected to provide 
coverage for an uncertain number of attacks in the future (that cannot 
be scientifically modeled) without the establishment of a Government 
mechanism that can provide a backstop for losses caused by terrorism. 
While most insurance policies today exclude damage from war, they 
typically do not include terrorism exclusions.
    The problem now is that many understandably skittish domestic and 
foreign reinsurers stated that they would not cover terrorist acts when 
contracts come up for renewal on January 1. Primary insurers warn they 
cannot support repeated terror claims, especially if reinsurers exclude 
such losses from coverage. Without reinsurance, insurers will leave 
markets, exclude terrorism coverage or charge premiums that, in 
essence, will make insurance coverage unaffordable and largely 
unavailable. The specter of any of these options has dire ramifications 
for commercial consumers of insurance products that need the financial 
protection offered by insurance to stay in business and on commercial 
life insurers, agents, and brokers that serve them. Failure to address 
this potential coverage gap will thus not be felt only within the 
insurance industry but on the national economy as a whole.
    Development of a terrorism reinsurance pool to cover commercial 
policies is critically important not just to insurance companies, 
agents and brokers, but also to the future viability of literally 
hundreds of thousands of small and large U.S. businesses. Without some 
kind of mechanism to cover terrorism losses, insurance protection would 
be difficult--if not impossible--to find, financiers would be reluctant 
to lend, and businesses would be hesitant to invest. The end result is 
an economic shockwave to the U.S. economy. No one wants to return to an 
insurance market like the mid-to-late 1980's when the lack of available 
or affordable insurance altered the business and personal activities of 
Americans. Therefore, the issue of terrorism reinsurance is critical.
    For this reason, IIAA supports the creation of a Federal backstop 
to ensure that the industry will be able to continue offering coverage 
for damages caused by terrorism. In establishing such a backstop, we 
will be able to restore coverage for the millions of businesses that 
will otherwise be unable to renew their current insurance policies and 
we will be able to restore the confidence customers rely upon in 
securing their needs through all insurance policies.
    When insurance industry representatives testified before the U.S. 
House of Representatives Financial Services Committee on September 26, 
the panelists' concerns focused more on the future than the present, 
and all seemed to agree that the U.S. Government must play a role in 
addressing the need for terrorism reinsurance. IIAA believes that 
Congressional action is necessary, and we believe the creation of a 
Federal backstop is a necessary element of any proposal that attempts 
to address these issues. The establishment of a Federal backstop would 
help ensure the continued solvency of the insurance industry, stabilize 
premiums, allow reinsurance companies to have renewed confidence to 
underwrite primary insurers, and make terrorism coverage available to 
the buyers who urgently need it. Regardless of whether it is the 
stability expected from the proposed establishment of a U.S. Treasury 
Federal backstop that the insurance industry agrees upon, a division of 
future terrorist claims between the insurance industry and the Federal 
Government suggested by the Administration, or a hybrid proposal, the 
core objective must be to insure that mechanism are instituted to 
enable small and large businesses to purchase insurance policies that 
might otherwise be unavailable or unaffordable in the wake of the 
September 11 attacks. IIAA pledges to continue working with the 
Administration, Members of this Committee, consumers, our industry 
colleagues, and any others to ensure that an appropriate solution is 
attained. The issue of terrorism reinsurance is so vital to the future 
of American businesses and to the health of the Nation's economy that 
it needs the immediate attention of Congress. Without a backstop for 
acts of terrorism, most insurance companies have two options stop 
writing many types of commercial insurance or charge significantly 
higher premiums. The specter of either option has dire ramifications 
for many business owners and agents and brokers. The impact on 
independent agents and brokers and their business clients is such a 
major concern that IIAA believes prompt Congressional action is 
absolutely necessary. We are very pragmatic when it comes to drafting 
and moving legislation to address this national issue. While interested 
parties may have differing opinions on how such a mechanism should 
work, we believe it is far more important to expeditiously work through 
differences to achieve the timely enactment of a proposal that can meet 
the immediate and long-term needs of the customers of independent 
agents and brokers, We stand ready to work with you on this important 
national issue.
                               ----------
                      STATEMENT OF MARC H. MORIAL
                  Mayor of New Orleans, Louisiana and
                  President, U.S. Conference of Mayors
    My name is Marc H. Morial, and I serve as the Mayor of New Orleans, 
as well as the President of the U.S. Conference of Mayors. I appreciate 
the opportunity to submit this statement in support of Federal 
legislation to create a reinsurance mechanism to help manage future 
terrorism risk.
    The U.S. Conference of Mayors has been in Washington this week 
meeting with Governor Ridge regarding the efforts of the Office of 
Homeland Security to protect our Nation from heinous terrorist acts 
such as the World Trade Center and Pentagon attacks of September 11, 
and the more recent distribution of anthrax through the U.S. mails.
    We are hopeful that the Office of Homeland Security, as well as the 
other fine efforts of Congress and the Administration, will prevent 
future terrorist attacks on U.S. soil. However, in the event that such 
attacks may occur, insurance is critical to the ability of cities like 
New Orleans to protect themselves, their residents, and the businesses 
located within them from ruinous financial harm.
    Unfortunately, the possibility of further terrorist attacks has 
made property/casualty insurance against the terrorism risk virtually 
unobtainable. This market crisis will be greatly exacerbated very soon, 
since many reinsurance and commercial 
insurance contracts come up for renewal each January 1. Reinsurers 
already are saying they will exclude ``acts of terrorism'' from 
coverage on a going-forward basis. Primary insurers may soon seek to 
follow suit. Such exclusions would leave municipalities and airports, 
as well as their residents and business citizens, greatly exposed to 
future losses. The immediate enactment of Federal terrorism reinsurance 
legislation is needed to avert this market crisis. Cities like New 
Orleans need to focus their efforts on preventing future terrorist 
attacks, not on struggling to find insurance in a market that does not 
have the financial capacity to address our needs.
    The need for a Federal terrorism reinsurance program affects us at 
several levels. First, our Nation's economy is in turmoil and was in 
trouble before the September 11 tragedy. Now in the aftermath, we 
recognize that certain economic sectors are further imperiled. It is 
important for Congress to enact an economic stimulus program. America 
needs to create new jobs for its workers and help keep the people who 
have jobs employed. But this effort may be all for naught if there is 
no insurance. Insurance is a critical element supporting our Nation's 
economic infrastructure. We can talk stimulus all we want but without 
insurance no one is going to build new buildings, no one is going to 
invest capital in new ventures, no one is going to employ the people 
who live in our cities and towns. Our economic well being is dependent 
on the availability of insurance.
    Second, many cities carry private sector insurance for our 
municipal properties, municipal workforce, and liability exposures. In 
the absence of insurance, we simply do not have programs in place to 
manage terrorism risk. Moreover, even assuming we can obtain coverage, 
if the price of insurance skyrockets because insurers have no way to 
even begin to quantify this exposure, these cost increases must be 
passed through to our taxpayers, at a time when many of them have seen 
their income drop as a result of the indirect effects of the September 
11 tragedy. While we recognize that Federal legislation is not going to 
remove this risk entirely from our portfolio, a Federal backstop to 
private insurance will help us to better manage this risk.
    Third, our residents and corporate citizens need to obtain their 
own insurance coverage. While this need exists nationwide, based on the 
attack on the World Trade Center some people perceive that the cities 
in our Nation have a greater terrorist threat. If businesses which 
choose to locate in urban areas cannot obtain insurance, they may 
relocate to suburban or rural areas, robbing us of critical economic 
development and the resulting tax base. For cities like New Orleans 
that rely heavily on tourism, it is also critical that hotels and other 
tourist destinations in urban areas can get insurance, or they may be 
forced to shut their doors, robbing us of the revenue that tourists 
bring to establishments throughout our city.
    Fourth, cities throughout the United States rely on insurers to 
invest in municipal bonds. In 2000, the par value of municipal bonds 
held by the insurance industry in the United States totaled 
$212,443,600,509 (102,368 issues), and for the State of Louisiana, 
$2,590,746,580 (1,835 issues). Moreover, nearly two-thirds of the 
property/casualty insurance industry's assets, or over $500 billion, 
are invested in governmental bonds, with the vast majority of these at 
the municipal level. These bonds are essential in allowing State and 
local governments to finance everything from schools, parks, highways, 
sewer, and water facilities to airports and senior citizen housing. If 
another major terrorist attack occurs, and insurers do not have 
adequate capacity, insurers would be faced with selling billions in 
bonds. This, in turn, could depress the value of bonds as huge volumes 
are liquidated, particularly in an economic downturn environment, 
making it more difficult for State and local governments to finance new 
projects or to rebuild.
    For cities like New Orleans, the consequences of the impending 
terrorism insurance market failure are real and serious, from the 
perspective of our own risk management programs, the preservation of 
our tax base, and the viability of our municipal bond offerings. I urge 
Congress to take immediate legislative action to address this issue as 
part of our Nation's efforts to enhance homeland security.
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