In a new report, Moody’s Investors Service concludes that terrorism risk remains significant for companies in the commercial lines insurance industry and that some companies face considerable risk management challenges in the absence of federal legislation backing up losses caused by foreign terrorists (known as the Terrorism Risk Insurance Act of 2002).

Moody’s report is based on its recent survey (and interviews) with a broad range of commercial lines insurers representing 60% of subject commercial lines direct written premiums. “In the absence of legislative action,” says assistant vice president James Eck, “the fact that TRIA is set to expire at year-end 2005 introduces additional complexity to insurers’ risk management efforts.”

He explains this is so because exposures currently being underwritten would no longer benefit from the federal backstop, which provides up to US$100 billion of reinsurance for losses arising from terrorism caused by foreign terrorists.

Eck notes the credit quality of commercial lines insurers may not be impacted after a major terrorist attack, as long as losses from such events are “less than 10% of an insurer’s equity capital.” Nevertheless, he also points out “commercial lines companies that have more aggressive risk postures with respect to terrorism could see more pronounced rating declines than their more conservative peers if a severe terrorism event occurs.”

According to the report, Moody’s expects highly-rated commercial lines insurers to appropriately manage terrorism risk through policy exclusions (where available), as well as by limitations on aggregate exposures, and also by use of risk transfer and risk pooling mechanisms.

“The results of our survey indicate that many commercial lines carriers have made significant progress in quantifying their potential terrorism risk exposures during the past two years,” Eck says. “But the data also suggests that some companies do not really have an adequate grasp of their assumed risks and potential liabilities.”

“In the absence of TRIA,” the analyst continues, “It is likely that widespread terrorism exclusions will again become the norm for commercial lines policies.”

“However,” he states, “terrorism coverage for workers’ compensation is mandatory, and certain states require property insurance policies to provide coverage for all fire losses, including those arising from terrorist events.”

In Moody’s opinion, private reinsurers are unlikely to fill the reinsurance capacity void if TRIA expires – at least in the near term. “Consequently,” says Eck, “many insurance carriers–particularly the major workers’ compensation writers–could be faced with dangerously high levels of risk aggregation, unless these companies substantially reduce their exposure to large accounts.”