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Putting a Price On Terrorism


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Putting a Price On Terrorism - Tammi Brown and Doug Butler, of MIJS, reflect on terrorism as an insurable risk and how captive assignations for premiums should be organized.

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Putting a Price On Terrorism

  1. 1. 8 CAPTIVE REVIEW | MICRO CAPTIVES REPORT 2017 MICRO CAPTIVES | MIJS D ue to heightened scrutiny of terrorism coverage provided through small captive insur- ance programs and the related litigation currently pending in the United States Tax Court, some industry professionals have (sur- prisingly) adopted the position that a small captive program’s legitimacy could be questioned if such captive provides terrorism coverage. The apparent foun- dation for this (minority) opinion is that because terrorism claims are remote, and premiums charged for terrorism coverage are excessive when compared to terrorism endorsements available on the commercial market, the “excessive” rates are charged solely for tax benefits1 . While there may be bad actors within the captive industry who write excessive premiums for terrorism coverage only to market the captive as a means to increase deductions, terrorism nonetheless remains a very real risk for business own- ers. Thus, a properly structured captive insurance program which offers terrorism coverage and charges actuarially-deter- mined premiums is a practical option that should remain available to all business owners. In the wake of September 11 2001, even after Congress passed the Terrorism Risk Insurance Act (TRIA) to provide a rein- surance market for P&C providers, the Government Accountability Office pub- lished two separate reports noting that (in addition to the $5m loss threshold and requiring a terrorist act to be certified as such by the government), procurement of the TRIA endorsement would likely not protect insureds against all acts of terrorism, including acts of terrorism involving nuclear, biological, chemical, and/or radiological (NBCR) agents, and that the few carriers that do offer NBCR coverage charge very high premiums as compared to premiums for a stan- dard TRIA endorsement. In fact, a 2008 report issued by the RAND Corporation “While it is true that NBCR premiums are justifiably higher than commercially procured terrorism endorsements, this does not give captives licence to randomly assign outrageous premiums” PUTTING A PRICE ON TERRORISM Tammi Brown and Doug Butler, of MIJS, reflect on terrorism as an insurable risk and how captive assignations for premiums should be organised
  2. 2. 9 CAPTIVE REVIEW | MICRO CAPTIVES REPORT 2017 MIJS | MICRO CAPTIVES and international events during recent years have established not only that the threat of terrorism and political violence is real and increasing, but also that this increasing threat presents real risk man- agement challenges that cannot be ade- quately addressed through commercially available products. As supported by the 2017 Aon Report and as conceded by the IRS, in as much as terrorism is a real, insurable risk, logically, the only remaining question is how to price terrorism. While it is true that NBCR pre- miums are justifiably higher than commer- cially procured terrorism endorsements, this does not give captives license to ran- domly assign outrageous premiums; rather, captives should use actuarially-determined premiums. As the US Tax Court held in Acu- ity v. Commissioner, as long as the actuary operates within standard accounting pro- cedures, it is not the Tax Court or the IRS’s place to question actuary pricing8 . For this reason, it is critical that terrorism premi- ums be priced by a licensed independent actuary with the skill and competence to accurately price such coverage. Additionally, the IRS also admitted that the fortuity of terrorism events is essen- tial for another function of insurance: risk pooling and the law of large numbers9 . “Fortuity is the reason for risk pooling and distribution, and a definition of insurance that focuses on risk pooling and distribu- tion thereby also contemplates fortuity as the core trigger of those insurance con- tracts.”10 Given the high severity loss that an act of terrorism can produce, some captive owners may find it advantageous to pool their collective terrorism risks together. Small captives that pool their risks together can provide coverage to their insureds that, due to limited surplus and reserves, they would not be able to offer on their own. These reinsurance pools allow small captives to have access to reinsurance which they could not otherwise afford. By participating in a reinsurance pool, each small captive diversifies its exposure to risk by assuming numerous, independent, and unrelated risks, and as a result, decreases the likelihood that a catastrophic loss will lead to bankruptcy. Terrorism is one of the largest risks faced by business owners, and it is nearly impos- sible to insure against the most devastating acts of terrorism through the commercial market. It is thus both necessary and appro- priate for business owners to insure against terrorist attacks, including NBCR events, through properly structured captive pro- grams. 1 Designating premiums charged by captive insurance companies as “excessive” ignores the fact that premiums for captive policies that providecoverageforNBCReventsarejustifiably higher than commercially procured terrorism endorsements that exclude NBCR events. 2 See United States Government, Program Management Leadership and Commitment, (last visited July 14, 2017). 3 Aon Risk Solutions, “2017 Risk Maps” p. 32. 4 Id. p. 54. 5 Id. p. 54. 6 Id. 7 Avrahami et al. v. Commisioner, United States Tax Court Docket No. 17594-13, 18274-13, Seri- atim Answering Brief filed October 2, 2015, p. 343. 8 See Acuity v. Commissioner, United States Tax Court, T.C. Memo. 2013-209 filed September 4, 2013. 9 Id. pp. 342-43. 10 Id. p. 343. estimated that damages from a simulated NBCR attack in southern California could cause damages totaling nearly $1trn. Captive insurance programs can close the vast coverage gap left by TRIA endorsements by providing coverage for NBCR events, not setting a minimum damage threshold, and not requiring acts to be certified by the government to trigger coverage. Despite the fact that we have borne witness to numerous “terrorist” acts since September 11 2001, in the last 16 years, not one single act of terrorism has been certified as such by the US government, including the 2013 Boston marathon bombing. Additionally, if the May 2017 bombing of the Ariana Grande concert in Manchester, UK had occurred on US soil, due to the heavy burden for certi- fication under TRIA, it is conceivable that such a blatant act of terrorism would not have been certified as such, thus leaving local businesses with no coverage to pro- tect their property and revenue streams. According to the Department of Home- land Security, after a natural or manmade catastrophe, nearly 40% of small businesses never reopen2 . In 2017, Aon released a report stating that the number of terrorist attacks increased worldwideby14%in2016–witha174%risein incidents, Western countries saw the great- est percentage increase in the frequency of terrorist violence of all regions in 20163 . Locally, the overall terrorism and political violence risk in the US rose due to increased risk related to Islamist and far-right terror- ism, as well as civil unrest arising from polit- ical and racial tensions4 . Additionally, there have been at least eight terrorist attacks in the US in 2016, all of which appeared to have an Islamist motive5 . Following an Islamic State (IS) attack at Ohio State University in November 2016, the US Homeland Security Committee cited the incident as further proof that the US remains in the “cross- hairs of Islamist terrorists”6 . Moreover, in December 2016, (now former) FBI director James Comey stated that 80% of the agency’s 1,000-plus active domestic terrorism inves- tigations are linked to IS. Despite this compelling data, some still question the real risk terrorism poses to the US. The Internal Revenue Service (IRS), however, does not dispute that terrorism is an insurable risk7 . The IRS has admitted, in judicio, that because it involves only fortu- itous events that are outside the control of the insureds is an insurable risk, terrorism is an insurable risk. Additionally, national Doug Butler joined Moore Ingram Johnson and Steele in 2009 in the Regulatory, Alternative Risk Transfer, Captive Management, Corporate and Transactional Law Departments. Butler received a degree in Finance from the University of Georgia in 2000. Doug worked in the life insurance industry for five years before attending Mercer Law School in 2006. Doug was admitted to the State Bar of Georgia in 2009. Butler’s practice is primarily focused on formation and management of captive insurance companies. Doug Butler Tammi Brown joined Moore Ingram Johnson & Steele’s Litigation Department in 2011 focusing on insurance/liability defence. Following undergraduate studies, Brown worked with a Fortune 200 insurance company for several years before attending Thomas M. Cooley Law School as an honors Scholar. Brown is admitted to practice in all state and superior courts of Georgia and US district courts for the northern and middle districts of Georgia. Tammi Brown