Advisors need to be alert in the coming months when clients' insurance policies come up for renewal. By early 2002, terrorism exclusions on policies threaten to send the insurance market into a tailspin, and the reverberations could well extend into the overall economy.

This is a chief concern of John Morrison, who heads up a legal-issues task force for the National Association of Insurance Commissioners (NAIC). "If the federal government does not provide coverage, we're going to have a very difficult problem on our hands," Morrison says. "This could affect businesses working in large buildings or high-profile enterprises. Airlines are at the top of the list of those affected. One act of terrorism could shut down a company. The ripple effect of that insurance problem for the airline industry could be very large on the American economy."

Terrorism exclusions, following the September 11 terrorist attacks, are being widely discussed for property-casualty policies. "I believe life companies are also talking about it," Morrison says. By the beginning of 2002, he says, most property-casualty policies are expected to be renewed and will have an act-of-terrorism exclusion.

Morrison notes that so far, about the only viable plan of relief to the insurance industry was proposed by President Bush in October. Under the proposal, the government would split the cost of property claims arising from terrorist attacks. Taxpayers in 2002 would pick up 80% of the first $20 billion in costs and insurers the rest. The Associated Press reports that under the plan, the government's share of costs would decrease gradually through 2004 and end after that.

If no agreement is reached on a government-assisted program to cover terrorist attacks, Morrison says, state insurance commissioners may consider prohibiting terrorism exclusions. At this writing, he said, there was no clear sentiment on that issue.

So far, terrorist claims have not been much of an issue. Terrorism exclusions only began appearing in a few commercial insurance policies after the Oklahoma City bombing in April 1995. The industry already has agreed to pay all claims for the terrorist attacks on the World Trade Center and Pentagon.

However, estimates on the cost of those attacks already are as high as a whopping $60 billion. Only one reinsurer-in the country of Bahrain in the Persian Gulf-has said it would not cover acts of terrorism, according to John Oxendine, Georgia's insurance commissioner, who is studying the reinsurance issue for NAIC. That Bahrainian company, he says, was not believed to have had any claims after World Trade Center attacks.

The insurance industry can handle the World Trade Center attacks, but it is a strain, Oxendine notes. Not yet known is the impact of business-interruption insurance and wrongful-death lawsuits.

Oxendine says the greatest industry fear is another disaster-whether it be a major hurricane, earthquake, terrorist attack on a major city, or even an attack on another country. Reinsurers hardest hit by the World Trade Center attacks, he says, have been Berkshire Hathaway's General Re; Zurich Re, now known as Converium; Swiss Re; and General Electric Co.'s Employers Re.

Besides claims, an added threat to insurers is the toll the economy has taken on their assets. Gregory V. Serio, New York State's superintendent of insurance, addresses that issue in testimony before the U.S. House Committee on Financial Services. The average stock-bond split of property and casualty insurers licensed in New York state is 27% in stocks, 53% in bonds, he reported on September 26.

On that date, he says, the value of these assets had fallen an estimated 2% since the World Trade Center disaster on average. Life insurance companies, he says, had a far more conservative stock-bond mix-4% in stocks and 77% in bonds. "For life insurance companies, the market impact of the past weeks' events was negligible," Serio says. "The rise in value of ... bonds due to a fall in interest rates compensates for the loss in other asset classes.

"For some individual companies (with larger holdings in equities and high-yield bonds), the market impact is more negative," Serio acknowledges. "Combined with the claims from the WTC disaster, their capital levels may fall to a level which causes enhanced monitoring by the department, but in no event do we now foresee a scenario that is likely to lead to insolvency."

As a result of the September 11 terrorist attacks, it is more important than ever to examine clients' insurance policies. Even if there is no terrorism exclusion, coverage also may be threatened if clients have exclusions for acts of war.

There is some good news for clients concerning act-of-war exclusions, however. A federal circuit court ruled in the 1970s that acts of war do not include acts of terrorism, Morrison said. The court, in that decision-Pan Am vs. Aetna-also ruled that the Palestine Liberation Organization, which had hijacked the Pan Am plane, was not a sovereign state. And acts of war, the court determined, can only occur between "sovereign states."

"Anthrax is not perpetrated by a sovereign state," Morrison observes. "There may be a legal question for the courts to address concerning whether the Taliban is a sovereign government. The attributes of sovereignty usually include recognition by an international community. The Taliban is not generally recognized by an international community. Clearly the acts of al Qaeda are not considered acts of war.

"On the other hand, if Saddam Hussein gets involved, the government of Iraq is recognized as a sovereign state. Losses associated with that would be arguably acts of war."

Morrison says that act-of-war exclusions are in almost all commercial property insurance, some life insurance policies and some health insurance policies.

After the September 11 terrorist attacks, Allstate Insurance spokesman Michael Trevino had reported that while that company had no act-of-war exclusion on life insurance, one did exist on the accidental-death rider. Acts of war typically are excluded on Allstate's homeowners' and renters' insurance, but not from auto insurance coverage. Although Allstate coverage depends on the specific policy and state laws, Trevino says that personal-articles coverage typically would contain an act-of-war exclusion. Trevino notes that Allstate defines "act of war" as "armed aggression by one or more countries opposed on the orders of any other country, group of countries or international body."

Blue Cross Blue Shield of Florida reported its policies had an act-of-war exclusion, while Blue Cross Blue Shield of Massachusetts did not. UnitedHealth-care in Minnetonka, Minn., said it has an act-of-war exclusion. In the past, says spokesman Roger Cruzen, that has applied to an act of war in the traditional sense-a declared war-one country against another, involving citizens who are sworn to fight that war on behalf of their nation.

"The question now," Cruzen continues, "is do we have a different set of boundaries-or definition-in the aftermath of these incidents (at the World Trade Center). I don't know if anyone has the answer to that. But people shouldn't panic that they're not going to have health coverage. The industry has shown an effort to do the right thing and to address these issues."

So what should you be doing for your clients amid all this confusion?

Glenn S. Daily, a New York-based insurance consultant, says that the World Trade Center attacks underscored the importance of life insurance in a financial plan. As he sees it, the attacks also make a stronger case for term insurance over cash-value insurance. He cites all the job losses after the World Trade Center attack. "People make a commitment when they buy a high-commission cash-value policy to keep paying the premiums," he says. In this uncertain environment, he says, policyholders need to be flexible.

"Look carefully at the coverage you would direct your clients into," advises Morrison, who also serves as Montana's state auditor, insurance commissioner and securities commissioner. "Find out whether there's been a new exclusion for terrorism. Make a calculated decision with the client whether terrorism is a risk they need to be concerned about. If it is, you need to either find a company that's not excluding it, or look to the insurance department to find out whether limitations are being placed on those exclusions. Keep an eye on Congress to find out whether a federal terrorism insurance plan provides a backstop."