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Difficulty: MediumTerrorism Risk Insurance Act (TRIA)

An attack on a regional power grid results in 135millionintotalindustry−wideinsuredpropertyandcasualtylosses.TheSecretaryoftheTreasury,inconsultationwiththeSecretaryofHomelandSecurityandtheAttorneyGeneral,officiallycertifiestheeventasanactofterrorism.Aparticipatingmutualinsurancecompanyprocesses135 million in total industry-wide insured property and casualty losses. The Secretary of the Treasury, in consultation with the Secretary of Homeland Security and the Attorney General, officially certifies the event as an act of terrorism. A participating mutual insurance company processes 25 million in covered claims for policyholders who had explicitly accepted the mandatory terrorism coverage offer. Under the provisions of the Terrorism Risk Insurance Act (TRIA), how is the financial responsibility for these specific claims allocated?

  1. The mutual insurance company is fully responsible for paying the claims because the aggregate industry-wide losses failed to reach the federal program trigger threshold.Answer
  2. B
    The federal government will reimburse the insurer for 80% of the claim costs since the event was officially certified by the required federal authorities.
  3. C
    The policyholders must absorb the losses because the insurer's contractual obligation is voided if aggregate damages remain below $200 million.
  4. D
    The insurer will pay its statutory deductible and refer the remaining balance to the state guaranty association to cover the lack of federal funding.

Answer

The mutual insurance company is fully responsible for paying the claims because the aggregate industry-wide losses failed to reach the federal program trigger threshold.
Under TRIA, while an event only needs to cause 5millioninpropertyandcasualtydamagetobecertifiedbytheSecretaryoftheTreasury,federalfinancialassistancedoesnotapplyuntiltheaggregateindustry−wideinsuredlossesexceedtheprogramtriggerof5 million in property and casualty damage to be certified by the Secretary of the Treasury, federal financial assistance does not apply until the aggregate industry-wide insured losses exceed the program trigger of 200 million. Because the total losses in this scenario were only $135 million, the federal backstop is not activated. Consequently, the insurer remains entirely responsible for paying the covered claims of the policyholders who purchased the terrorism coverage.

Step-by-Step Solution

1
Analyze the conditions required for an event to be certified as an act of terrorism.
The event caused 135millionindamages,whichexceedsthe135 million in damages, which exceeds the 5 million minimum requirement for the Secretary of the Treasury to certify it.
Certification is the first necessary step for TRIA involvement.
2
Evaluate the financial threshold required for federal backstop funding.
TRIA requires aggregate industry-wide insured losses to exceed the program trigger of $200 million before federal cost-sharing begins.
The program trigger dictates when the government begins reimbursing insurers.
3
Compare the scenario's aggregate losses to the statutory program trigger.
The industry-wide losses (135million)arebelowthe135 million) are below the 200 million trigger, meaning no federal funds will be provided.
Determines the actual financial liability of the insurer versus the federal government.
4
Determine the insurer's contractual obligation.
Because the policyholders accepted the terrorism coverage, the insurer must fulfill its contractual promise to pay the claims entirely from its own reserves.
The insurer assumes the risk via the insurance contract, regardless of whether federal reinsurance applies.

Key Concept

TRIA Certification vs. Program Trigger Thresholds
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Topics

Terrorism Risk Insurance Act (TRIA)

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