Recently President Bush signed into policy, the much awaited terrorism bill. The insurance industry had been working behind the scenes to push this bill through with the argument that should there be another terrorist attack of the magnitude of September 11, 2001 it would fail. And if it failed, there would be millions of people out of work. This latter argument got the President's attention and helped to sway his decision to sign the bill.

If one were to read the press release by the President the major point he emphasises is that by signing this bill, he is in fact saving jobs for people.

There were apparently some work stoppages in the construction, real estate and related industry segments in the US because these industries were unable to purchase terrorism coverage, which is now a prerequisite for securing financing.

The industry was initially elated by this bill, but now, must face the consequences of the bill's passage. The first major consequence is that in the US, no insurer is allowed to exclude terrorism. After September 11, 2001, virtually every insurance company excluded terrorism in direct response to the actions of the reinsurers who decided to exclude it.

Now, insurers have to find a way to price a risk that is unquantifiable and as a consequence, virtually impossible to underwrite.

Many in the industry do not even know how to begin pricing the risk, let alone having to file rates with the individual state departments to let them know what they will be charging for this exposure.

Insurers are concerned about whether they will ever be able to come up with the "right" premium for terrorism - an exposure that is both fortuitous and potentially limitless. In my October 19, 2001 column about why insurers are excluding terrorism, I mentioned that prior to September 11, 2001, terrorism coverage in the US was given virtually free because there had never been a history of terrorism in the US.

After September 11, 2001, the perspective on terrorism coverage fundamentally changed.

No longer was it looked upon as an unlikely hazard but rather as one that was very likely to occur and when it did, its outcome could become limitless, placing insurers in a very untenable position.

How does one go about pricing a risk that was once thrown in as a bonus but could now bankrupt even the strongest of companies? The industry is vulnerable at this time because although many are getting significant premium increases; they are not gaining significant investment returns. Recently, John Phelan of American Re stated that the decline in the equities market in 2002 has had the "single biggest impact on insurers and reinsurers".

In the United States, insurers must file their rates, term and conditions with each state insurance department where they conduct business. The complicating factor of operating under this system is that there is rarely consistency between state departments.

Therefore, just because an insurer was able to have his rates, terms and conditions approved in one state does not mean they will automatically be accepted in another. Insurers are scratching their heads.

The US Department of Treasury has tried to combat this complex regulatory bureaucracy of the US insurance industry by stating that should insurers use the model disclosure form approved by state insurance commissioners, they will be in full compliance with the new federal backstop. The National Association of Insurance Commissioners (NAIC) has also released a bulletin to help to expedite the process of filing rates and rules.

In addition, insurers must now separately state how much they are charging for terrorism but the rates cannot be too "excessive".

Yet the commissioners have not yet clearly defined what is deemed to be excessive. This is where problems will arise for insurers from state to state and make the process of providing terrorism coverage very arbitrary and difficult.

Herein lies the dilemma for the Bermuda insurance industry. When the President Bush decided to pass this bill; his goal was to protect the US economy.

However, the passage of this bill has now actually created a huge disparity between insurance companies based on their geographic locations.

Bermuda insurers will be faced with the dilemma of whether they should provide terrorist coverage to remain competitive with the US market.

They will also be challenged by their clients to provide consistency of coverage throughout their insurance programme.

Many clients tend to purchase primary limits in their domestic markets and excess limits in places like Bermuda.

Because a majority of the clients that come to Bermuda are US based, they will by virtue of the terrorist bill have primary coverage, which includes terrorism.

They will expect their Bermuda excess carriers to cover terrorism as well.

Therefore Bermuda insurers will feel pressured from both their clients and the forces of the marketplace to provide a coverage for which they have no backstop.

Consequently, Bermuda insurers are at an unfair disadvantage to their US counterparts before they even begin to try to price for terrorism.

Unlike US insurers who have a defined terrorism exposure of $10 billion in the first year, after which the Government will step in up to a maximum cap of $100 billion, Bermuda insurers will be exposed to an undefined terrorism exposure amount.

Hence, Bermuda insurers should be charging higher premiums than their US counterparts for terrorism coverage and they should be imposing sublimits for the terrorism exposure or requiring minimum attachment points.

Initially Bermuda companies will probably make sound underwriting decisions about how to underwrite for terrorism. However, when clients elect not to purchase insurance from them because they feel the underwriting measures imposed are not competitive, many insurers will begin to relax their underwriting standards to gain marketshare.

It is my opinion that once the industry starts to relax its underwriting standards, it will be making a huge mistake considering the state of the economy and investment results not being favourable.

I recently read the insurance business is finding it very difficult to deliver the minimum 3% return it has traditionally paid to investors.

I understand the need for the US to put into place a federal backstop to try to stimulate certain industries like construction, real estate, etc, which have been devastated by 9/11.

However, the implications of a federal backstop for insurance companies only in the US does not help the global insurance industry to remain whole in the event of another large terrorist loss which will likely occur in the United States.

Another interesting twist to the federal backstop is that reinsurance is not a regulated industry in the US and therefore those that provide reinsurance are not required to provide terrorism coverage.

And for those of us who understand insurance it is actually reinsurance that enables the fundamental principle of insurance to work, the spread of risk amongst many carriers.

Without the "backstop" of a reinsurer, many insurers will be vulnerable to having to pay out on a significant terrorist loss without having the benefit of spreading that risk around to others.

Is this federal backstop a good or bad thing? Only time will tell. To me it's a classic case of being careful of what you wish for.

@EDITRULE:

Cathy Duffy is a Chartered Property Casualty Underwriter (CPCU) and is now a freelance writer. She is a former executive of Zurich Global Energy and has 15 years experience in the insurance industry. She writes on insurance issues in The Royal Gazette every Monday. Feedback crduffycwbda.bm