Managing Exposure in the New Age of Terrorism†

 

Jean M. Lawler

Sarah J. Timberlake

 

I.

Introduction

The catastrophic events of September 11, 2001 have renewed focus on the war risk exclusions in insurance contracts.  Before the dust settled and fires were extinguished in New York City and Washington D.C., President Bush and Members of Congress were calling the attacks “acts of war” and declaring the United States at war against world terrorism.  At the same time, government officials were urging insurers not to exercise the acts-of-war exclusion to deny coverage relating to the attacks.

A number of major insurers, including Northwestern Mutual, Chubb Corp., Swiss Re, Hartford Financial Services Group, Ace Ltd., Met Life Inc., Prudential Financial, and CIGNA have acquiesced, agreeing the acts on September 11 were terrorism and therefore did not trigger the war exemptions.[1]  However, not all insurers, in particular reinsurers, have committed on whether they will invoke the act-of-war exclusion and thus, the debate continues.

The applicability of these exclusions to claims arising out of the September 11 attacks are not quite as simplistic as the news media suggests.  There are valid concerns that retaliation, triggered by our country’s war against terrorism and military efforts in Afghanistan, is likely and insurers will again face applicability of the war risk exclusion under a different set of circumstances while still experiencing the financial fallout of the September 11 events.[2]  Further, some question whether insurers’ determination not to apply their policies’ war risk exclusion with respect to September 11 claims could preclude the assertion of the exclusion in the future on grounds they have waived the right to do so.[3]  These issues and others have insurers and policyholders scurrying for a solution to a risk that was once theoretically discussed and is now real and foreseeable, not only abroad, but in the United States.

This article will briefly address the legal history of the war risk exclusion, its potential applicability to claims resulting from the attacks of September 11 and actions insurers are taking to reduce their exposure for similar risks in the future.

 

II.

The War Risk Exclusion

The attacks on the World Trade Center and Pentagon triggered claims under a variety of policies each having its own variation of the war risk exclusion and some none at all.  Many of the claims will be governed by the following exclusion published by the Insurance Services Office, Inc. in contemporary policies which utilizes several broad terms besides “war” to describe the exclusions’ scope.

 

6.                War and Military Action

(1)             War including undeclared or civil war;

(2)             Warlike action by a military force, including action and hindering or defending against an actual or expected attack, by any government, sovereign or other authority using military personnel or other agents; or

Insurrection, rebellion, revolution, usurped power, or action taken by governmental authority in hindering or defending any of these.[4]

 

No court decisions have addressed the exact language of the war exclusion clause in the current commercial property forms.  Although the language in the exclusion provisions appears sufficiently broad to cover an attack of the magnitude on September 11, 2001, decisions addressing past war exclusions reveal courts have traditionally adopted narrow meanings of the terms “war” and “military action” in construing these exclusions.  American courts, following British precedent have adhered to a strict doctrine of what constitutes war, applying the exclusion only in situations where the damages arise from a genuine warlike act between sovereign entities.[5]

The law established in Pan Am will be pivotal in any coverage issue arising from the recent attacks on the World Trade Center and Pentagon.  The applicability of the war risk exclusion was addressed in this case under the following circumstances.  Two men acting for the Popular Front for the Liberation of Palestine (PFLP) hijacked a 747 El Al plane from Amsterdam and forced the crew to fly to Beirut where a demolitions expert and explosives were put on board.  The aircraft was then flown to Egypt under PFLP control.  In Cairo, after passengers were evacuated on short notice, the aircraft was blown up and totally destroyed.  There was no loss of life.  The 747 was insured by all-risk private insurers, war risks insurers from London, as well as the United States Government.  The all-risk insurance and war risk coverage provided by London Underwriters included war exclusions.  The courts were asked to decide the issue of whether any of the war risk exclusions applied.  If so, then the insurers would not be liable and the United States would have to pay the $9.8 million excess.  If inapplicable, then the insurers would share the loss and the United States would pay nothing.  Both the trial court and the court of appeals concluded the exclusions were inapplicable requiring the all-risk insurers to share the loss.

            The Court of Appeals for the Second Circuit in affirming the decision of the trial court issued a thirty-three page opinion that examined in detail the meaning of specific policy terms in light of the facts and prior case law.  It took into consideration decisions from early British and American cases on war involving the American Civil War, World Wars I and II, and the Korean Conflict.  Based on this legal history, the court held:

 

The cases establish that war is a course of hostility engaged in by entities that have at least significant attributes of sovereignty.  Under international law, war is waged by states or state-like entities . . . and includes only hostilities carried on by entities that constitute governments at least de facto in character.[6]

 

            Because the PFLP never claimed to be a state, the Second Circuit reasoned this activist group could not be acting on behalf of any of the states in which it existed when the plane was hijacked, especially since those states uniformly and publicly opposed hijacking.  The hijackers were agents of a radical political group and not a sovereign government.  The court concluded a gorilla group or radical political group must have at least some incidence of sovereignty before its activities can properly be defined as war.[7]

            Subsequent to the decision in Pan American, there has been little case law published which specifically addresses war exclusions, particularly in the context of first-party property or business income insurance.  Cases since Pan Am have expressly followed its precedent or dealt with other issues consistent with its holding.  In Holiday Inns, Inc. v. Aetna Insurance Co.,[8] the court, extensively quoting from Pan American, declined to apply the war risk exclusion to a claim for damages to a hotel that was shelled during battles in Beirut, Lebanon.  The court focused on the faction occupying the Holiday Inn at the time of the fighting and concluded that it was not a sovereign entity.  It noted that even if the group could be argued to possess the necessary sovereignty, it was not fighting with another sovereign government at the time of damage.

            In TRT/FTC Communications, Inc. v. Insurance Company of the State of Pennsylvania,[9] the applicability of war risk exclusions was addressed under a manuscript policy in the context of the 1989 United States invasion of Panama.  The Panamanian National Assembly passed a declaration proclaiming a state of war existed between the United States and the Republic of Panama on December 15, 1989.  Five days later on December 20, the United States military forces invaded Panama City resulting in civil disorder.  TRT/FTC Communications occupied space on the ground floor of a building in the business district of Panama City.  Several persons dressed as civilians but carrying AK-47 military assault rifles broke into TRT’s ground floor facility on December 21 and stole merchandise and equipment.  In the coverage litigation that followed, the court concluded the war risk exclusion applied to preclude coverage.  It determined the men who robbed TRT were part of an arm of the Panamanian Government’s forces involved in the war effort.  The court noted that regardless of whether the men were part of the Panamanian forces or a band of looters, there was ample evidence to support the conclusion that their actions against TRT were enabled by the military hostilities occurring between Panama and the United States.[10]

Another consideration to be taken into account in the application of war exclusions is precedent that provides the loss must arise from a hazard existing only in wartime and not in peacetime.  For example, in Queen Insurance Co. v. Globe & Rutger’s Insurance Co.,[11] the Supreme Court ruled damage from a collision of two merchant ships sailing with separate convoys during World War I, with no hostile warships apparently present, was not a war risk.  The damage caused by the collision was such that it could have occurred at any time, not just during war.  In Aircraft International, Inc. v. United States,[12] an insured was denied coverage based on the war exclusion for aircraft lost in Vietnam during the war when it collided with a military aircraft.  The court held the loss was due to an aviation risk even though the two aircraft were flying over Vietnam only because of the war.  The Florida Supreme Court in American Fire & Casualty Co. v. Sunny South Aircraft Services, Inc.,[13] concluded the war exclusion should not apply against a claim for loss to an aircraft hijacked to Cuba and then damaged by a Cuban military plane.  It reasoned theft rather than warlike activity caused the loss.  The theft was determined not to be a hazard separate and distinct from that of peacetime even though the plane was damaged by a warplane.[14]

Unless additional facts are revealed that prove the terrorist attacks on September 11 were directed by some government or sovereignty at least de facto in character, then it will be very difficult for insurers to succeed in any coverage dispute involving war risk exclusions.  Although recent events have changed our common understanding of the word “war,” it is unlikely courts will reverse their traditional narrow view of the standard war exclusions.[15]

III.

Terrorism Exclusions

            In response to the new realities of the insurance market, the questionable applicability of war risk exclusions to losses related to acts of terrorism, and faced with reinsurers refusing to reinsure terrorism related losses after January 1, 2002, property and casualty insurers have turned to newly drafted terrorism endorsements.  This was done to minimize their exposures and ensure their continued ability to negotiate acceptable reinsurance treaties.  Insurance companies, insurance service organizations, attorneys, underwriters and others involved in drafting insurance policies began writing terrorism endorsements with the intent of excluding from coverage any loss, cost, expense, exposure or other damage, of any kind, that might emanate from terrorism or threats of terrorism.  Meant to clarify that the policies to which they are attached do not provide the insured with coverage for damages that fall within the scope of the exclusion, or only provide limited coverage, these endorsements are as varied as the companies and underwriters drafting them.  However, without exception, these forms clearly have at their core the intent to limit coverage that might otherwise be available for losses that result from terrorism or terroristic activities.

Manuscript terrorism exclusions are perhaps the most broadly worded.   By way of example is the following form, drafted to be used on property policies:

 

Acts of Terrorism or Terroristic Threats

(1)        We will not pay for loss, damage, cost or expense of whatsoever nature caused directly or indirectly by, resulting from or in connection with “acts of terrorism” or “terroristic threats.”  Such loss or damage is excluded regardless of any other cause or event that contributes concurrently or in any sequence to the loss.

(2)        We will not pay for loss, damage, cost or expense of whatsoever nature caused directly or indirectly by, resulting from or in connection with any action taken in defending, controlling, preventing, suppressing or in any way related to “acts of terrorism” or “terroristic threats.”

If such acts or threats also come within the terms of the War and Military Action Exclusion, that exclusion supersedes this Terrorism exclusion.

If an act of terrorism involves nuclear reaction, nuclear radiation, or radioactive contamination, this Terrorism exclusion will apply to losses that result from such nuclear reaction or radiation or radioactive contamination in place of the Nuclear Hazard exclusion.

 

ADDED DEFINITIONS:

 

“Acts of terrorism” means any act or activity that is dangerous to human life or property, is disruptive of public, private, governmental or business services or operations, or is in any way threatening to the health, welfare, or economic well-being of the general public, whether such act or activity is committed in the United States or anywhere else in the world, and which act or activity has the apparent intent of, or otherwise results in:

(i)         Terrorization, harm, intimidation or coercion of a civilian population; or

(ii)        Exertion of influence on the policy or conduct of a government by intimidation or coercion, assassination or kidnapping; or

(iii)       Direct or indirect interruption or disruption in public, private, governmental or business services or operations; or

(iv)       Direct or indirect interruption or disruption in the manufacture, supply, distribution or sale of goods, products, or services; or

(v)        Direct or indirect interruption or disruption in the use of technology or the Internet; or

(vi)       Harm to persons or property.

“Terroristic threat” means a threat to commit any “acts of terrorism” or other act, activity or crime of violence with the purpose to terrorize another or to cause evacuation of a building, place of assembly, or facility of public transportation, or otherwise to cause serious public inconvenience, or in reckless disregard of the risk of causing such terror or inconvenience.

“Acts of terrorism” and “terroristic threats” include, but are not limited to, acts or activity that are of a criminal nature as provided for by the laws of the United States or any State of the United States, regardless of where in the world such acts or activity may occur.

“Acts of terrorism” or “terroristic threats” further include any such act or threat encompassed within the meaning or intent of any antiterrorist statute or law of the United States or State of the United States.[16]

 

Other manuscript terrorism endorsements utilize differing definitions of “terrorism,” some using language that is more focused on the activity and the apparent intent of the terrorist, while others utilize language focusing on the result.  One of the challenges of these endorsements is to distinguish between acts of violence that typically could lead to covered losses and acts of violence that are in the nature of terrorism.  The new terrorism laws provide some guidance in this regard, but those definitions may be too limiting.  Note the importance in not limiting the exclusion to acts of terrorism directed to a government.  As we saw after September 11th, and which we continue to see, the breadth and depth of damages that can emanate from an act of terrorism affects businesses in ways that would previously have not even been considered.  Hence, disruption to business, technology (which might not involve a violent event), and other day-to-day public and private operations is a key exposure to be eliminated or minimized by these endorsements.  A variation on complete elimination of coverage would be having a sub-limit for terrorism losses.  However, that has its own potential problems if there is ever an issue as to whether the sub-limits or the entire limits might be available in the event of a covered loss.

In addition to manuscript terrorism endorsements, the Insurance Services Office, Inc. (ISO) and the American Association of Insurance Services (AAIS) have filed terrorism exclusion forms excluding coverage for terrorism related damages under various types of property and casualty policies.   Both ISO and AAIS began filing their forms in November 2001 on behalf of their member companies, in anticipation of January 1, 2002 reinsurance renewals.

On December 21, 2001 the National Association of Insurance Commissioners (NAIC) announced that, “[w]ith the inaction by Congress [in enacting insurance terrorism legislation], state regulators have been placed in the unfortunate position of having to approve some exclusions in order to protect the solvency of companies in the commercial lines market.  By doing so, they will ensure the continued availability of coverages other than terrorism,” said NAIC President and Iowa Insurance Commissioner Terri Vaughan. “We urge Congress to act on this issue immediately upon their return. Only Congressional action can bring stability back to the market in the short run. . . Given Congress’ failure to act, regulators will begin allowing insurers to exclude terrorism losses if a terrorist act causes total insured losses exceeding $25 million.”[17]

In making its comments, the NAIC noted that its members had been working with ISO to create limited exclusionary language acceptable to both regulators and the insurance industry.  It commended ISO for its work in this area as well as its decision to offer the forms to non-ISO property and casualty companies without charge.  Insurers that are current licensees of ISO for policy forms can use the new language pursuant to their current ISO agreements and state approval of the forms.  Non-ISO companies can contact ISO for copies of the terrorism exclusion forms, and permission to use them, by contacting the ISO customer service department.[18]

As noted, AAIS has also filed forms of terrorism exclusions on behalf of its members, in those states that are accepting terrorism endorsements for commercial lines of insurance.  In particular, as of February 26, 2002, AAIS announced that it is not pursuing the approval of its terrorism endorsements in California, Florida or New York, based on the positions established by the insurance commissioners in those states.[19]  The AAIS commercial lines endorsements are referred to as War, Military Action and Terrorism Exclusions.  AAIS also has terrorism forms for personal lines policies but is not filing these endorsements with state regulators, that required obligation being left to the individual insurance companies wishing to use the forms.[20]  Basically, the homeowner forms are either a “complete” terrorism endorsement, or include a more limited exclusion for nuclear, biological and chemical events.[21]  Unlike the war exclusions in the commercial lines endorsements, these forms specify that the discharge of a nuclear weapon is deemed an act of war, even if accidental.[22]

A state-by-state list of contact persons for questions regarding Terrorism Exclusions is maintained by the NAIC.[23]

 

IV.

Conclusion

 

As we enter this new age of terrorism, both war and the war risk exclusions as we have known them are evermore changed.  The war risk exclusions of "old" are being modified and updated to include terrorism exposures through any combination of means, whether reduced coverage limits, caps on coverage amounts, outright exclusions or any one of a multitude of other variations.  Simply stated, with terrorism as a fact of post-September 11th life in the United States and western Europe, the insurance market and the risks that it will insure have been forever altered.  How businesses, governments and the insurance industry respond to this new risk will have a major impact on the economic growth and vitality of the free world. Managing this exposure has become the challenge for our times.

 

ENDNOTES

 


†           An earlier version of this article was published in the Winter 2001-02 issue of Dedclarations, the publication of the Excess/Surplus Lines Claims Ass’n and is adapted with its permission. It is submitted by the authors on behalf of the FDCC Transportation Section.

[1]           See Lee Bergquist, NML to Honor All Attack Claims; Insurer Won't Cite “Acts of War” Exclusion, Milwaukee J. Sentinel, Sept. 15, 2001, at 1D (Northwestern Mut. Life Ins. Co.); Tamara Loomis, Crisis Management: Terrorist Actions Prompt Laudable Responses, N.Y. Law J., Sept. 20, 2001, at 5 (Chubb Corp., Swiss Re, and Hartford Financial Services Group); Christopher Oster, Ace Joins Insurers That Won't Invoke Act‑of‑War Clause, Wall St. J., Sept. 20, 2001, at B2 (Ace Ltd.); David Pilla, Life Insurers Dismiss War Exclusion, Best's Ins. News, Sept. 18, 2001, available at 2001 WL 24724943 (Met Life Inc., Prudential Financial, and CIGNA).

[2]           Randy J. Maniloff, The War Risk Exclusion – Looking Beyond the Events of September 11th, Mealy Publications, Dec. 3, 2001;  James G. Rizzo, Tragedy’s Aftermath: The Impact of 9/11 on the Insurance Industry, 46 B. B.J. 10, 13 (Jan.-Feb. 2002).

[3]           Id.

[4]           Form CP 10 30 06 95, ISO Commercial Risk Services, Inc. 1994.  The AAIS Forms include the following language:

C. War – “We” Do Not Pay for Losses Caused by War.  This means:

1)               Declared war, undeclared war, civil war, insurrection, rebellion, or revolution;

2)               A warlike act by a military force or by military personnel;

3)               The destruction, seizure, or use of the property for a military purpose; or

4)               The discharge of a nuclear weapon even if accidental.

[5]           Pan American World Airways, Inc v. Aetna Cas. & Sur. Co., 505 F.2d 989 (2d.Cir. 1974).

[6]           Id. at 1012.

[7]           A detailed analysis of the Pan Am decision is impossible in this limited space.  Thorough reading of the decision confirms the issues are not cut and dry but are rather complex and require an investigation of all factual issues, including the political climate and circumstances under which the events took place, an analysis of each part of the exclusion was required in order to make the correct coverage decision.  Insurers need to be aware there is more to the war exclusion than an interpretation of the terms “war” and “military action”.  In Pan Am, the court also addressed the other terms in the exclusion such as “warlike operations,” “riots,” “insurrection” and “civil commotion” and concluded they did not apply.

[8]           571 F. Supp. 1460 (S.D.N.Y. 1983).

[9]           847 F. Supp. 28 (D. Del. 1993).

[10]          Coverage was found for looting and vandalism following the U.S. invasion of Panama City under a policy that included an Endorsement covering “civil commotion assuming the proportions of or amounting to a public uprising.”  This was in spite of the fact the war exclusion in the manuscript policy was determined to apply to the loss.  The court reasoned the Endorsement added language to and took precedence over the manuscript policy.  The term “public uprising” was found not to assume an element of political revolt and that looting was a “civil commotion” even though provoked by foreign attack.  Sherwin-Williams Co. v. Ins. Co. of the State of Pa., 863 F. Supp. 542 (N.D. Ohio 1994).

[11]          263 U.S. 487 (1924).

[12]          460 F. Supp. 1065 (5th Cir. 1972).

[13]          151 So. 2d 276 (Fla. 1973).

[14]          For a more thorough discussion of this issue, see Susan Massman, War Risk Exclusion Legal History Outlined, 16  Report on Claims from David Morse & Associates, No. 6, Nov. 2001.

[15]          Kathryn K. Jensen, Terrorism and War Exclusions – A Legal Analysis, Property Loss Research Bureau and Claims Magazine, available at the FDCC web site, www.the federation.org, under the FDCC Terrorism Coverage Home Page at War and Terrorism Coverage and Exclusions Under Traditional Liability Policies.

[16]          Text provided to one of the authors by client who requested anonymity.

[17]          NAIC Press Release, Dec. 21, 2001, as posted on its website located at http://www.naic.org/lnews/releases/htmlsA102601/122101_NAICMmbrsCmToAgrmntRgrdExcs.htm.

[18]          ISO Press Release, Dec. 21, 2001, as posted on its website located at http://www.iso.com/docs/pres262.htm. ISO may be contacted at 1-800-888-4476, or at info@iso.com.

[19]          As posted on the AAIS website, located at http://www.aais.org/.

[20]          http://www.aais.org/General/bul02-0100.htm.

[21]          http://www.aais.org/General/terror2-26-02.htm.

[22]          Id.

[23]          http://www.naic.org/terrorism_exclusions_contacts.doc.

(authors’ bios)

Jean M. Lawler is a senior partner of Murchison & Cumming and is resident in its Los Angeles, California office.  She serves as Chair of the firm’s Insurance Law and Risk Management Practice Group, focusing her practice on complex insurance litigation, insurance coverage matters of all types, insurance bad faith defense, underwriting, and advising businesses and insurers regarding insurance and risk management issues.  Ms. Lawler is a member of the State Bar of California, the Oregon State Bar, the Federation of Defense & Corporate Counsel (FDCC), Defense Research Institute (DRI) and the Association of Southern California Defense Counsel (ASCDC), and is an affiliate member of the Property Loss Research Bureau (PLRB).  She serves as the Secretary-Treasurer and a Director of the FDCC and is past chair of its Excess/Surplus Lines Substantive Law Section.  Ms. Lawler is a frequent author and lecturer on topics involving insurance and risk management. She is a graduate of Loyola Marymount University (B.B.A.) and Loyola Law School, Los Angeles (J.D.).  Murchison & Cumming is a civil litigation defense firm with three offices in Southern California and an office in Las Vegas, Nevada (in affiliation with Carraway & Ryan).

Sarah J. Timberlake is a member of the Oklahoma City firm of Abowitz, Timberlake & Dahnke. She is active in insurance, automotive, trucking, products liability, general tort and employment litigation. Ms. Timberlake earned her J.D. from the University of Oklahoma Law School and is a member of the Federation of Defense & Corporate Counsel (Chair of the Transportation Section and recently formed Terrorism Coverage Task Force), the Defense Research Institute, the Oklahoma Association of Defense Counsel (past President and Board Member) and the Oklahoma Bar Association where she has served as Managing Trustee of its Group Insurance Trust.  She has lectured and published in the fields of insurance and general liability.