Producers' guide to some terrorism coverage scenarios, by line Resource kit 90315

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1 Producers' guide Producers' guide to some terrorism coverage scenarios, by line Resource kit By Ellen D. Kiehl, Ph.D., CAE, and Dan Corbin, CPCU, CIC, LUTC PIA members have asked PIA about various types of situations that could present exposure to loss by terrorism under different types of policies. In discussing the choices presented by the federal Terrorism Risk Insurance Act (TRIA), clients often request examples or information on these scenarios as they weigh the decision of whether to accept or reject the coverage that is required to be offered by the act. Since the act covers a wide variety of policy types, these scenarios will vary depending on the coverage involved. Be sure you understand TRIA coverage. Describing the coverage required to be offered by TRIA is beyond the scope of this document, but is covered in PIA's QuickSource document No This guide is designed to be used in conjunction with that document, which explains what the TRIA coverage does and does not do. A key point to remember is that the act's terrorism coverage (i.e., coverage for insured losses arising from certified acts under the act) still remains subject to the policies' existing limits, exclusions, deductibles, aggregates and other policy terms. For example, standard property policies will likely contain a war exclusion and a nuclear exclusion. Some policies also may contain exclusions for contamination by chemical/biological agents. Choosing the TRIA coverage will NOT provide coverage for damages attributable to perils or events that are otherwise excluded. Here's a walk-through of some types of policies and some considerations or scenarios illustrating terrorism exposures. Policies are divided into two major categories: property and property-type policies; and liability, including specialty liability policies. I. Property and property-type coverages Overview key points to discuss: Potential direct damage to property Buildings Business personal property Property of others Equipment breakdown (boiler and machinery) Crime Auto physical damage Potential business interruption

2 Business income Loss of rents Extra expense Any legal or fiduciary responsibilities to insure property Discussion: A word about Standard Fire Policy (SFP) provisions. In states with Standard Fire Policy provisions in their state statutes, policies cannot be offered that contain fire coverage that is inferior to the coverage described in the SFP. So, it is possible that even if the insured does not accept the TRIA coverage, the policy still would provide coverage for loss from fires following a terrorist event. This could vary depending on whether the company is admitted or nonadmitted or depending on the state where coverage is written. Check with your company as to the applicability of fire coverage to TRIA's "insured losses" if the insured declines TRIA terrorism coverage. Connecticut, New Jersey, New York and New Hampshire all have SFP laws. (Note: insurer trade groups are targeting state SFP laws with an eye to enacting amendments that would allow insurers to exclude fire following for terrorist events. PIACT testified against such a bill in Connecticut in February 2003.) Property insurance owners. Perhaps the clearest examples of terrorism scenarios involve property coverages. For the owner of the property, the exposure of the structure and contents to damage or destruction is relatively easy to grasp. Additional points for owners may be any responsibilities they may have to others whose property is on their premises, or to lenders under mortgage agreements that require coverage, including terrorism coverage, to be maintained. (Example: PIA recently saw a notice from Wachovia Securities, in its capacity of servicer for the mortgagee, to a property owner in Manhattan asking for a certificate of insurance demonstrating that terrorism coverage is in place.) Property insurance tenants. Tenants also will have property exposures for business personal property or personal property in their leased space. They also may find exposure under the provisions of their lease to maintain coverage; or they may have property of others in their care on a regular or occasional basis. They also may have a leasehold interest exposure if they enjoy a particularly favorable lease that they could not expect to duplicate at this location or elsewhere. Business Interruption. A direct loss to property normally results in indirect losses due to the interruption of business operations. There is a provision for covering this exposure in the property coverage part of commercial package policies and businessowner policies. So, coverage for possible business interruption losses arising from terrorist acts would be dependent on not having terrorism excluded from covered perils. Nevertheless, as the events of Sept. 11, 2001, showed, business interruption is a complicated coverage area. Some issues include provisions requiring that there be actual damage to the insured premises to trigger coverage; time limits to coverage for interruptions due to the action of civil authorities; possible separate coverage options that could broaden coverage to include disruptions from loss of utilities, communications or transportation in the neighborhood (not included in standard coverage); designation of a specific other site or sites that, if damaged, would trigger dependent property coverage, etc. PIA, following Sept. 11, prepared a consumer-oriented explanation of some of these issues, available as QuickSource document No Inland Marine. The issues are similar to those of property coverage. Any separate floaters should be considered in the same light as the property coverage. Items can range from small and valuable (jewelry) to large and relatively exposed (construction equipment). Also, these policies often protect property while in

3 transit, including imports/exports as well as the instrumentalities of transportation and communication, such as bridges, broadcast facilities, etc., which some may perceive as having higher intrinsic exposures to terrorism due to their nature. Equipment breakdown. Considerably more remote is the potential for direct and indirect losses that may occur due to the breakdown of boilers and machinery caused by a terrorist act. The property coverages will respond to most losses to boilers and machinery (assuming there is no terrorism exclusion on the property policy), because damage likely will be caused by such perils as fire or combustion explosion, rather than breakdown. Terrorist damage due strictly to equipment breakdown, and not also attributable to a covered property peril, has limited scope and is not as likely to exceed the "certified" act threshold of $5 million. Crime. Crime is another remote exposure. A terrorism exclusion may revoke coverage that is otherwise provided for criminal events, such as theft, computer fraud, funds transfer fraud or employee dishonesty, where a terrorist act is involved in the causation chain. Commercial Auto Physical Damage. Consider whether valuable equipment (e.g., emergency response vehicles) or a stationary fleet of parked or garaged vehicles could be lost in a terrorist event; also consider in conjunction with potential liability exposure (see below). II. Liability and specialty liability coverages Overview key points to discuss Liability exposure results from various legal duties to prevent or mitigate the severity of any loss from a terrorist event. Think alleged security lapses, construction defects and preparedness issues. Think "contributory negligence." After a terrorist event, survivors and family members will likely bring legal actions against a wide variety of parties, so the insurer's duty to defend is a key coverage element to consider, even if the likelihood of a judgment seems remote. Following Sept. 11, reasonable expectations and standards of duty may have changed because of people's awareness of this exposure and the explicit warnings and precautionary directions coming from Homeland Security. General Liability Premises. Defense costs are key. Claims can arise from allegedly lax security or failing to take steps that would prevent or mitigate loss, or faulty construction. Some examples would be claims involving charges of: inadequate security; inadequate PA/other warning systems; conflicting instructions; faulty maintenance of safety equipment/fire doors; stairways having insufficient capacity or failure to seal; failure of safety equipment to operate; lack of preparatory drills or evacuation plan. General Liability Operations. Should the operations of the insured contribute in any way to a terrorist act, the insured could incur liability (for example, a contracted maintenance worker inadvertently gives a terrorist access to critical instruments of terrorism). General Liability Products. Claims stemming from the client's products could involve, for example, the use of a product in the terrorist act (e.g., manufacture, distribution, sales of fertilizer or other bomb-making materials).

4 General Liability Completed Operations. For contractors or others involved in building design and construction, terrorism plaintiffs could allege contribution due to construction defects; using construction material that accelerates or otherwise increases damages; inadequate ventilation or egress design. Agents' Errors & Omissions. It is possible to make a case that no single other party has as great a chance of terrorism exposure as insurance agents and brokers. That is because wherever terrorism strikes, insurance producers could have one or more clients who may allege an error or omission in obtaining appropriate coverage. Because of the tight time frames, confusion, lack of adequate communication and inconsistency among insurance carriers in their implementation of TRIA, insurance agents and brokers may lack optimum paper trails documenting the offers that were communicated and the decisions that clients have made. PIA developed a resource, QuickSource document No , "Interpreting your companies' TRIA procedures: how to create a company-specific implementation checklist," to help insurance producers bring order to the implementation process. With respect to E&O, remember that DEFENSE COSTS are a prime consideration in whether to accept or reject any type of liability coverage. Additional E&O issues could arise from insurance companies' possible delegation of certain TRIA functions to their agents. Remember, failure to provide and document proper notices to insureds could void the insurer's financial backstop from the government! While TRIA allows insurers to use regular distribution channels (including agents) to contact insureds, the law is clear that the responsibility to comply rests directly with the insurer. But, should the company delegate certain functions, and the agent's execution somehow prove defective, so that the company could not collect its federal reinsurance following a loss, legal issues could arise between the agent and the company. Other types of professional liability. Medical malpractice is not included in TRIA. However, architects & engineers professional liability would defend and indemnify claims for faulty design in the wake of a terrorist calamity, while attorneys may face claims that they did not draw up legal documents such as leases, hold harmless agreements or other instruments correctly to eliminate or minimize their clients' legal or financial losses in the event of a terrorist event; and that their errors or omissions operated to the detriment of the client. Directors & Officers. Thinking about D&O exposures takes a bit more imagination. Claims against this policy could involve charges of poor decision making or poor execution of management duties that led to financial injury. Examples could allege an imprudent business decision (but failure to maintain insurance is excluded), or negligent supervision or improper training of employees that results in economic loss to others, such as suppliers or investors, from a terrorist act. Employment Practices. Employment practices liability excludes bodily injury, and covers only practices such as sexual harassment, discrimination and wrongful termination. It is difficult to construct scenarios where a terrorism exposure would be involved with this coverage. Commercial Auto Liability. Claims under this policy could arise from alleged failure to safeguard the vehicle in the case of a hijacking. Special consideration should be made if the vehicle transports passengers for hire. Vehicles transporting hazardous or volatile substances also may present special exposures to use as part of a terrorist attack. A word about public entities. Robert Hartwig, chief economist at the Insurance Information Institute, says that school districts should consider taking TRIA's insurance because the eventuality of a terrorist attack affecting a school cannot be ruled out and school districts have an enormous amount of exposure with buildings, vehicles, property, and most importantly, human life. Hartwig notes that many municipalities and school districts have not purchased the coverage because they think that if anything happens the government will provide emergency

5 funds. However, the point of TRIA is to provide a mechanism for insuring terrorism exposure through the insurance market, and public funds may not be forthcoming again on the same scale as following Sept. 11. Also, even New York City has needed to struggle in order to collect the funds it was promised. A municipality may think it can self-insure because of its tax base. But, if property values and economic activity were decimated following a terrorist attack, revenues could be impacted accordingly. (This information is general in nature. It is not intended to provide advice about individual legal, business, coverage or other questions, to recommend a course of legal action or to constitute a promise of action by any party. It addresses selective topics and does not claim to be a complete summary of TRIA, of any insurance policy, or of any of their provisions. Consult the TRIA and the individual insurance contract for more details or your attorney for legal advice.) 3/03 PIA your best source of information With respect to all information found in this communication, PIA of Florida and its directors, officers, members, or employees make no warranty, express or implied, or assume any legal liability or responsibility for the accuracy, completeness, or usefulness of any information contained therein. PIA of Florida does not warrant that the information or services will meet any specific requirements; nor will it be error-free or uninterrupted; nor shall PIA of Florida be liable for any indirect, incidental, or consequential damages sustained or incurred in connection with the use of information in this communication. Under no circumstances will PIA of Florida be liable for any loss or damage caused by anyone's reliance on information contained in this communication. 1-05