Reaction time

Two and a half years after the devastating attacks on the World Trade Center (WTC), the full extent of the damage is still unknown. It is currently estimated that insured losses are around $40bn (£22.02bn), but current litigation could affect the amounts owed by insurers significantly.

The WTC attacks were the biggest single loss in the history of the insurance industry – and also one of the most complex. The initial reaction among many commentators was that insurance companies could face financial ruin. Some insurers posted pessimistic reserves, others played down their exposure to the losses. Only a few were proved to have made accurate initial assessments.

Some important lessons appear to have been learnt, one being that the insurance industry may become more robust. One issue, brought into sharp relief by the ongoing and high-profile Silverstein litigation in the US, is that the not-infrequent industry practice of delaying the agreement of detailed policy terms needs to be addressed.

Direct effect on the insurance industry?

The WTC losses struck the entire industry and affected almost every line of business. It has been estimated that nearly 150 insurers and reinsurers worldwide have been affected. The total loss in the London market is estimated to be £12bn.

Claims have been made on numerous types of policies, including life insurance policies, those protecting property (for the loss of the Twin Towers and damage to surrounding buildings and vehicles), personal injury (PI), business interruption and workers’ compensation claims. Hull claims have also been made for the loss of the aircraft involved.

Insurers have responded to claims made by those directly affected by the attacks, as well as to claims made by those sued by third-party victims of the attacks. For example, the Port Authority of New York has been sued for negligent design and maintenance of the Twin Towers, inadequate safety features and inadequate evacuation procedures. Similarly, the airport security companies and airlines face allegations that they failed to take reasonable actions to protect against terrorist attacks. Each of these entities carried liability insurance.

Mitigating factors

Despite initial pessimism, the insurance market has not been as badly hit as early reports suggested. The interplay of a number of factors has been important.

The first is the nature of global reinsurance. The sharing of the risk between more than 100 companies has meant that the burden has been spread relatively widely, rather than falling on only a few companies. Even Lloyd’s, whose gross exposure has been calculated at £5.7bn, expects to reduce its net liability, after reinsurance recoveries, to £1.9bn.

Second, the courts have so far determined that the attacks on the WTC were one occurrence, rather than two (World Trade Center Properties LLC v Hartford Fire Insurance Co (26 September 2003), US Court of Appeal, Second Circuit). An important exception to this is the Silverstein litigation, which is currently before the US courts. Larry Silverstein, the leaseholder of the Twin Towers, is suing various insurers, led by Swiss Re. He claims that, under his property insurance contract, the loss should properly be seen as two separate losses. This would mean that insurers would be liable for over $7bn (£3.85bn), as opposed to $3.5bn (£1.93bn) (which Silverstein claims would be insufficient to rebuild the site). The case turns on which of two policy wordings applies. One clearly provides that the attacks should be considered to be one occurrence; the other is silent on this point. Unfortunately, neither form of wording had been finally agreed by 11 September.

A third factor is the operation of the victims compensation fund, which was established to provide compensation for those physically injured or killed as a result of the attacks. Victims who made claims on the fund waived their right to litigate. It is reported that more than 95 per cent of those eligible applied, including fire-fighters and other rescue workers, with a total of 7,304 claims. Only 143 of the families of those killed on 11 September have not filed a claim.
Nevertheless, many of these are expected to bring lawsuits against the airlines, the Port Authority and other potentially liable entities, which are likely to result in additional claims against the insurance market.

Finally, the events of 11 September also saw premiums driven up. This was coupled with a large increase in demand for property and aviation insurance, and to some extent in life insurance. The two years following the attacks were also unusually quiet in terms of large losses, allowing many insurers the opportunity to regroup and recover.

Effects on underwriting approach

As a result of 11 September, the insurance industry has inevitably reassessed how its exposures are calculated and managed.

Before the attacks, it had been thought the maximum loss from terrorist acts would be analogous to property losses from fire or explosions. Similarly, ‘catastrophes’ were more often considered to be natural disasters such as hurricanes or floods, rather than man-made events. Now, however, claims have reached proportions never considered possible and the industry has a new model against which to calculate potential maximum exposures.

Risk management and the quality of the information available to insurers regarding their potential exposures is key. For underwriters to be able to rate a risk properly they need a full appreciation of the incidence and scale of the risk. Equally important is an understanding of the combined events of potential losses. Multiline insurers can easily accumulate a range of property, PI and workers’ compensation exposures at one site which can lead to huge accumulated losses as a result of events such as 11 September.

Finally, the structure of reinsurance programmes across the range of their business is of critical importance to insurers. The way losses are allocated as between insurer and reinsurer, and how aggregation provisions will work, needs to be more clearly understood by all parties.

Agreeing details of policy terms

The outcome of the Silverstein litigation is dependent on which insurers adopted which insurance wording and whether the attacks will attract two separate limits under the wording, which is silent on the point. If Silverstein is successful, an extra $3.5bn will have to be found.

Once again, insurers have been exposed to uncertainty and to the expense of litigation by the market practice of agreeing detailed terms only after cover has been provided. In no other area of commerce is the delay in agreeing detailed terms of the bargain until after it has been accepted so prevalent and so costly in terms of exposure to litigation. If there is one issue the industry needs to address to save unnecessary litigation expense, this is it.

Marian Boyle is a partner in the insurance and reinsurance group at Denton Wilde Sapte. She was assisted in this article by solicitor Anna March