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"New Terrorism Insurance Law Impacts Transportation Projects"

Nossaman Infrastructure
By: Fredric W. Kessler
01/06/03

The Terrorism Risk Insurance Act of 2002, H.R. 3210, Pub. Law 107-297, became effective November 26, 2002. The Act ushers in a period of federal support for property and casualty insurance markets in order to rejuvenate insurance of loss from acts of terrorism. In exchange for a substantial federal backstop of this risk, the insurance industry becomes obligated to offer terrorism risk coverage in all pre-existing property and casualty policies that excluded the risk, and in all new policies offered during the federal program. Premium rates for the coverage are unregulated by the Act (but remain subject to state regulation). What the markets charge for this coverage, with what deductibles, will be one of several key factors in determining whether the Act facilitates real protections for owners and builders of large transportation infrastructure development projects.

This memorandum briefly summarizes the highlights of this new, important and complex legislation.

Applicability

The Act mandates that insurers under all property and casualty insurance policies issued prior to or during the term of the Act offer coverage for an "act of terrorism". The Act does not reach losses suffered on September 11. The definition of insurers subject to the Act is complex, but encompasses, among others, licensed and admitted insurers and listed surplus lines carriers that receive direct earned premiums for any type of property and casualty insurance coverage.

Property and casualty insurance includes excess insurance, worker's compensation insurance and surety insurance. It does not include reinsurance, flood insurance, life and health insurance and certain other listed types of insurance. The Secretary may extend the Act to group life insurance upon determining that the threat of terrorism is reducing the availability of reinsurance to group life insurers or of group life insurance to consumers.

An "act of terrorism" is whatever, and only whatever, the Treasury Secretary decides to call an act of terrorism. The Secretary's decision is "final, and … not … subject to judicial review", a provision that raises Constitutional issues regarding its enforceability. The Secretary is to determine if the act is violent or dangerous, results in damage within the U.S. (or to certain assets outside the U.S., such as to air carriers) and is committed on behalf of a "foreign person or foreign interest" in order "to coerce the civilian population of the United States or to influence the policy or affect the conduct of the United States Government by coercion." "Act of terrorism" excludes acts of declared war and acts resulting in aggregate property loss of $5M or less. Notably, terrorist acts committed by U.S. residents are not covered.

These identifying characteristics vary significantly from definitions of an act of terrorism which are starting to appear in insurance industry exclusionary provisions. These exclusions purport to encompass use of violence or force by any person, foreign or domestic, intended to intimidate or disrupt any government or any segment of the population, whether motivated by religious, political, ideological or social objectives, and encompassing damage not only to tangible property but to intangible assets. No interpretation of these exclusions is yet reported in the case law. Under an expansive reading that the insurance industry may propound, individual acts generally thought of as common criminality, such as vandalism, not to mention acts commonly understood as warfare, and much in between, arguably are excluded.

Mandatory Terrorism Coverage Mechanisms

For those policies issued prior to November 26, 2002, "any terrorism exclusion" from coverage is declared void "to the extent that it excludes losses that would otherwise be insured losses." State approvals of terrorism exclusions are likewise preempted. This language leaves it unclear whether the Act nullifies only exclusions within the Act's more narrowly defined "act of terrorism" or nullifies the much broader terrorism exclusions in property and casualty policies. In any event, for the time being, if you own a property or casualty policy issued before November 26 and it excluded terrorism coverage, you in fact have terrorism coverage at least for an act of terrorism as defined in the Act.

However, an insurer can reinstate the exclusion with written consent of the insured or if the insured fails to pay the added premium within 30 days after the insurer gives notice to the insured. These notices must be issued by February 24, 2003 and must disclose the right to coverage, the increased premium and the date the exclusion will be reinstated absent payment. Under interim regulations the Treasury Secretary has approved model forms of the National Association of Insurance Commissioners for the purpose of giving the required notices. Insured parties unaware of the provisions of the Act could misunderstand the significance of the notice. Additional insureds are not expressly entitled to the notice and may not receive it under policy terms, which typically require notice to additional insured parties only of policy cancellation or non-renewal of coverage.

For policies written after November 26, the insurer must offer coverage that "does not differ materially" from the terms and conditions for other casualty risk coverage, and must provide a disclosure statement "at the time of offer, purchase, and renewal of the policy" declaring the availability of coverage and separately stating the premium. Under the interim regulations, the requirement to offer materially similar terms and conditions allows deductibles and limits comparable to the coverage for other perils in the policy, and allows exclusions for certain types of risks and losses that need not be covered under state regulations, such as nuclear, biological and chemical events.

Federal Backstop

The federal government will take 90% of the insured loss up to an annual aggregate cap on its liability. Insurers must carry the other 10% up to an annual aggregate cap on their collective liability. The federal government has no responsibility for annual aggregate insured losses in excess of $100 billion. The insurance industry cap starts at $10 billion and increases to $15 billion in the third and last year of the program. Aggregate losses above the annual caps remain uninsured. The Treasury Secretary is to allocate the insurance industry's annual cap among all casualty and property insurers.

The Treasury Secretary is granted discretionary authority to impose a policy premium surcharge not exceeding 3% of the total premium on all property and casualty insurance policies in force to spread and recoup the federal government's losses under the program. The Secretary may weigh a variety of factors in determining whether to impose risk-spreading premiums and where to allocate them among various types, sizes and locations of properties, based on economic impacts and potential exposure to loss. Such a surcharge on policies carried under a contractor-controlled insurance program could entitle the contractor to a change order, depending on the contract provisions, particularly provisions dealing with changes in law.

National Federal Litigation Scheme

The Act preempts "all state causes of action of any kind" for property damage, personal injury or death arising from an act of terrorism as declared by the Treasury Secretary and substitutes an exclusive federal cause of action. For each act of terrorism, the forum for the federal cause of action is to be in one or multiple federal district courts as designated by the Judicial Panel on Multidistrict Litigation. The law of the state in which the act of terrorism occurred, including its choice of law principles, is to be applied. A party's contractual right to arbitrate disputes is not affected by these provisions.

These litigation management provisions may be difficult to apply in practice to contracts for design and construction of large transportation infrastructure projects. These contracts often include provisions for claims, change orders, indemnification and dispute resolution that do not neatly fit into the federal scheme. For instance, is a contractor's claim for damage or destruction of work of improvement that occurs in the course of construction due to a terrorist act a claim for property damage subject to original and exclusive jurisdiction of a federal court? If a contract sets forth contrary dispute resolution mechanisms, would the obligation to litigate in federal court not apply because it would unconstitutionally impair these contract rights? Must a claim under a contractual indemnity against liability to third parties due to a terrorist act be litigated in the designated federal court, or is it distinct from the primary cause of action for damage, personal injury or death? Hopefully, no events will trigger disputes over these questions.

Sunset Provisions

The Act and the federal program expire December 31, 2005, except administration and adjustment of payments and compensation and recoupment for terrorism losses arising during the program period. There is an exception. The provisions mandating insurers to make available coverage for acts of terrorism is to end December 31, 2004, unless the Treasury Secretary decides, by no later than September 1, 2004, to extend this date one additional year. It is hoped that the insurance marketplace will settle out by that time and once again be able and willing to extend terrorism coverage at affordable rates without federal support. That will depend upon intervening events.

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