United States: Commercial Insurance Issues Following The World Trade Center Disaster

Originally published in September 2001

The horror which descended upon New York, the United States and the World on September 11, 2001 was first and foremost a personal tragedy in which the loss of human life cannot be adequately measured. Commercial matters pale in comparison to these losses and we at Ross & Hardies lament the unfathomable deaths which are still being counted and pray that the injured will have a full and speedy recovery. We marvel at the strength and bravery of all those public servants and private persons who responded to the tragedy and who have provided comfort and assistance to those harmed.

Clients of the firm have inquired about the implications of this disaster on their continuing businesses. While realizing that any opinion expressed must be of a very preliminary nature since events are still unfolding, one important area of concern is the viability of commercial insurance markets.

One day after the attack, Warren Buffet, Chairman of Berkshire Hathaway, stated in a CNN televised interview that reinsurers affiliated with his companies could have a difficult time meeting their obligations to primary carriers and that reinsurance insolvencies can be expected. The magnitude of covered losses is only now being estimated, and they are staggering, reaching as much as $40 billion-the largest insurance loss in history. While many primary carriers are offering reassuring signs that claims are fully covered, Morgan Stanley Equity Research has noted that such reassurances are in many cases based on net losses following reinsurance recoveries, not gross loss estimates. But the problem is that some reinsurance underwriters did not anticipate the multiple lines of loss which came together in this disaster. So-called "clash events" in which unanticipated multiple loss lines when aggregated are beyond the ability of the reinsurer to cover.

What does this mean to our business clients? Insurance is a cornerstone of business, and companies which insure with prime insurers have always counted on the security that this asset provides, whether in the form of liability insurance, business interruption coverage or property loss security. A failure of the reinsurance sector has the potential to effect not only those who suffered direct losses from the Trade Center attack, but also others with insured claims for which no insurance proceeds will be available. There is a clear ripple effect.

There are some safeguards. The Lloyd's market, for example, is mutualized in which security exists through both the Central Fund and insurance to cover defaulting syndicates. But the Central Fund is limited to about £320 million and insurance is in the amount of another £500 million. It is speculated that a portion of the insurance would not be recoverable in the scenario under discussion and the amounts, in any event, are well below the magnitude of the covered losses. Lloyd's has recently issued a statement denying liquidity concerns.

Another factor is government support to rebuild infrastructure and provide disaster relief. Already, Congress has authorized $40 billion in assistance. A government cash infusion will ameliorate a portion of the unrecoverable insured losses, but it is premature to speculate on the significance of this on reinsurance markets.

Finally, clients should be aware that there may be a protection to the insurance market through the terms of the policies themselves. Most commercial business policies contain an exclusion for Acts of War or warlike operations. There are many versions of the exclusion. For example, the 1973 Commercial General Liability (CGL) terms, Exclusion I, provides:

Bodily injury or property damage due to war, whether or not declared, or any act or condition incident to war. War includes civil war, insurrection, rebellion and revolution. This exclusion applies only to liability assumed under a contract or agreement.

Questions will no doubt arise whether Act of War policy exclusions apply to the World Trade Center losses, although insurers may be loathe to raise any such defense even if arguably applicable because of adverse public reaction.

As demonstrated by the 1973 CGL form, many policies do not require a formal declaration of war for the exclusion to apply. Some policies are silent on this. In cases immediately following the outbreak of hostilities leading to our entry into World War II, specifically the attack on Pearl Harbor, courts concluded that losses sustained in that attack were excluded as "incident to war," and that a formal declaration was not necessary for the exclusion to apply. Subsequent cases were less charitable to insurers holding that the exclusion did not apply until war was declared. Similarly, cases involved in the Korean and Vietnam conflicts reached contrary results leading to uncertainty as to the scope of the exclusion.

The events of September 11, 2001 were apparently the act of one or more international terrorist groups not formally associated with a sovereign power. While not entirely uniform, most courts have concluded that the exclusion, unless the wording says otherwise, applies to hostilities between two or more sovereign powers. Whether or not the Taliban, which controls most of the territory comprising Afghanistan, is a "sovereign power" or whether they and other nations offered comfort and support to the terrorists, is irrelevant, since the hostile acts appear to have been carried out by these terrorist organizations.

There is a parallel to claims made following the PanAm Lockerbie crash in 1973, in which terrorists placed a bomb aboard a New York bound flight from London. In that case, PanAm's insurers argued that the Act of War exclusion applied to the terrorist attack. The Federal Appeals Court in New York held that the acts of a non-sovereign terrorist group are not acts of war within the meaning of the policy exclusion and thus rejected the insurer's policy defense.

Some primary carriers have already begun to settle Trade Center claims; thus, the market is operating normally in some cases at this early stage. There can be little doubt that claims and litigation will arise from these tragic events. Whether the insurance industry will be in a position to cover these losses remains a matter of speculation, but it will be prudent for business to consider the possibility of insurance insolvencies going forward. We suggest, at the least, that clients contact their brokers to review the security of the insurance programs covering their risks and liabilities.

The Corporate, Insurance and Insolvency Groups at Ross & Hardies are available to provide more specific advice to clients who may be concerned about these and other business issues which have arisen following the events of September 11, 2001. In particular, we are available to conduct insurance audits both to analyze policy issues and to work with your brokers to assess liquidity risks.