Terrorism insuranceEffectively modeling and profitably insuring terrorism risk

The insurance industry continues to explore ways to insure against terrorism risk, finding it a challenge despite developing various methodologies to measuring the likelihood of a terrorist attack.

Property and Casualty360 reports that Risk Management Solutions (RMS), in a recently published white paper, argues that terrorism insurance is in actuality the insurance against the failure of counterterrorism. “The frequency of such failures is low because of concerted suppressive Western government counter-terrorism measures, which are stepped up even further after any successful act of terrorism,” RMS says. The key to modeling terrorism risk, according to RMS, is to model terror activity at a strategic, rather than tactical, level. “Dealing with terrorist operations at a tactical level is a task for government officials, not risk-modeling agencies,” RMS notes.

RMS models terrorism risk as a “control process by which terrorist operations are countered by security and intelligence services.” The company insists that the work of a risk analyst is to assess the likelihood of an event occurring, not to predict or prevent an attack. The robust counterterrorism efforts in North America and Europe assure RMS that the annual volatility in terrorism losses involving conventional weapons “is actually lower than for natural hazards.”

RSM explains that the probability of multiple natural disasters occurring in a single year is “highly uncertain,” whereas “the possibility of a wave of successful terrorist attacks against the U.S. homeland in a single year is extremely remote” owing to the counter-terrorism response which would follow any successful attack.

Terrorism risk and natural disasters are often compared and contrasted within the insurance industry. The financial risk of terrorism is comparable to that of natural disasters. RMS notes that return periods used in the reinsurance industry for severe winter storms and convective storms such as 1-in 100, 250, and 500 years can also apply to terrorism. “At longer return periods, financial impacts can be comparable with earthquakes and hurricanes,” RMS explains. Terrorism and natural disasters differ in terms of risk with respects to rare events with highly severity levels. “Many natural catastrophes occur with relatively high frequency, the range of possible damages are better understood and insurance companies can more accurately underwrite their loss potential,” RMS says. “Successful large-scale terrorist attacks, however, are events that may only occur once a generation or less.”

Even the most severe terror attacks, involving nuclear, biological, or radiological attacks “may cause hundreds of billions of dollars of damage, but have an extremely low frequency attached.” A natural disaster will most likely occur over a widespread area, while with terrorist attack the damage is limited and measured in square yards. A contrast of damages from Hurricane Katrina and the 9/11 attacks can be made.

Property and Casualty360notes that Chris Folkman, terrorism risk expert at RSM, insists that because terrorism risk can be modeled, it can be effectively priced. According to Folkman, several insurance companies are effectively modeling and profitably insuring terrorism risk today; certain types of terror attacks, however, are more difficult to insure than others. Radiological attacks, for example, can affect a wider area when compared to conventional bomb attacks.

In terms of extending the Terrorism Insurance Act (TRIA), Folkman says RMS’s role is to “quantify risk as best as we can. We don’t hold opinion for or against” an extension. Several insurance companies would be hesitant to offer terrorism coverage without TRIA, and though terrorism risk models offer insurers an understanding of their risk exposure, Folkman warns that some insurers feel certain terror attacks of large magnitude could bankrupt the insurance industry.