Under Attack: Terrorism Risk Insurance Regulation

Scholarly debates over the September 11th attacks focus predominantly on high-profile issues, such as torture, preventive detention, interrogation, privacy, and surveillance. These debates have overshadowed the equally important and far-reaching issue of terrorism risk insurance, which not only involves billions of dollars, but provides powerful incentives to keep us safe. Developing a sound understanding of the market for terrorism risk insurance is essential to guiding the difficult determination of the appropriate balance between private and public responsibility for preventing and (when necessary) compensating for terrorism. The attacks of September 11th represented one of the costliest insurance events in American history. In the days that followed, insurers sought exclusions and limited coverage, making it difficult for commercial policyholders to purchase even basic terrorism coverage. Congress reacted by passing three successive pieces of legislation to make coverage available and affordable to property and casualty commercial policyholders and to stabilize insurance markets. Yet, current legislation is set to expire in 2014. What is next? Will the federal government withdraw from this market altogether? Should it? This Article argues for continued--though modified--regulation. The threat of terrorism is real. The ten years since September 11th have been the most active period in terrorism history. Federal regulation has helped to decrease prices and widen coverage, but imperfections in the market for terrorism risk insurance necessitate continued federal assistance. Federal regulators must intervene carefully, however, because a regulation that interferes with pricing inevitably affects policyholder incentives to take precautions to avoid or limit loss--the familiar problem of moral hazard. This Article presents a roadmap for continued regulation that solves the moral hazard dilemma and delineates the proper boundaries of federal regulation. The enormous challenges presented by the risk of terrorism can be addressed only through a coordinated, comprehensive system that melds ex ante preventive and mitigation measures, insurance mechanisms, and ex post compensation mechanisms into a national policy. In its innovative approach, this Article contributes to both the national security literature, which has paid scant attention to terrorism insurance, and to the insurance literature, which has paid insufficient attention to the problem of moral hazard in terrorism risk insurance