The document discusses the legitimacy and pricing of terrorism coverage in captive insurance programs amid heightened scrutiny and ongoing litigation. It argues that terrorism remains a significant insurable risk, necessitating actuarially-determined premiums for proper risk management, particularly considering gaps left by commercial insurance. Furthermore, it highlights the increasing threat of terrorism in the U.S. and calls for small captives to pool their risks to provide comprehensive coverage.

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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. 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,
http://www.ready.gov/program-management
(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