The Cost of Terrorism: Insurance issues and TRIA
Kurt Karl Swiss Re Economic Research & Consulting Global Interdependence Center Conference Dec., 2004 Slide 1
Introduction Frequency and severity of global terrorist attacks The insurance industry & how it works What is insurable? The Terrorism Risk Insurance Act (TRIA) TRIA benefits Conclusions
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Total International Terrorist Attacks: Frequency is trending downward All of decline from 2001 to 2002 due to Latin America
Number 700 600 500 400 300 200 100 0 1982 Slide 3
1987 Terrorism
1992
Source: Patterns of Global Terrorism, US State Dept.
1997 Column 2
2002
Insured catastrophic terrorism losses 1970–2003: Severity is up USD mn, at 2003 prices
Property and business interruption
20000
15000
10000
5000
0 1970 Slide 4
1975 1980 1985 Terrorism losses
Source: Swiss Re, sigma No. 1/2004
1990 1995 Column 2
2000
9/11 consensus loss estimates: $32.5 billion in total
Aviation Liability 11%
Other Liability 12%
Life 3% Property 30%
Workers' Comp 6% Event Cancellation 3% Aviation Hull 2% Slide 5
Business Interruption 33%
Source: Insurance Information Institute (III)
The insurance industry Insurance pricing cycle is determined by flow of capital into and out of the industry, “capacity” Insurance industry has limited capacity. – Commercial property insurance, $49 billion premiumis in 2003 – Workers compensation $48 bn. – All of commercial, including liability, $237 bn. 9/11 loss was a major strain on the US insurance industry Insurance industry does not have the capacity to insure catastrophes like 9/11 on an ongoing basis Slide 6
Distribution of P&C capital matters‌
US P&C surplus in $ billions segmented by dominate business lines $132 surplus back comml’ lines that are covered by TRIA
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Surplus 12/2003 $330.5 billion *
Personal lines
17
Covered by TRIA
132
Financial + A&H lines Commercial lines
143
Reinsurers * *) excluding National Indemnity Sources: A.M.Best, Swiss Re Economic Research & Consulting
42
Is terrorism insurable? - 1 Very problematic, according to a Rand Study: – Very large losses, that may happen rarely, requiring reserves be built up and held over long period of time – Difficult to predict type and frequency of attacks Source: Lloyd Dixon, et. al. “Issues and Options for Government Intervention in the Market for Terrorism Insurance,” Rand occasional paper, 2004. [Swiss Re one of ten sponsors of these terrorism studies.] Slide 8
– State governments might impose restrictions on coverage and rates – Difficult to spread risks across large base of buyers
Is terrorism insurable? - 2 Not measurable: cannot estimate severity or frequency. Models do exist, however, based on “Delphi” methods. The size of the maximum possible loss is beyond reasonable calculations (eg, a hijacked aircraft crashing into a nuclear power station)
Sources: Swiss Re, “Insuring the uninsurable,” sigma 1/2005, forthcoming.
Excessive adverse selection, only terrorist targets want insurance. Difficult to diversify the losses since terrorist actions can be coordinated throughout the world. Risks correlated. The business is probably not economically feasible Hence, there would be little insurance capacity provided
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Terrorism Risk Insurance Act (TRIA) Foreign terrorist act only, not domestic Insurance industry aggregate retention is $12.5bn in 2004 and $15bn in losses 2005 Only support 90% up to first $100 billion, after deductible, nothing after $100 bn Excludes: personal lines, assumed reinsurance, federal crop, med-mal, flood, L&H, and other lines Insurers must provide coverage (46% of companies buy it) Conclusion: not a particularly generous package for insurers Slide 10
Other government solutions: Pool Re in United Kingdom Pool Re, since 1993 (post-IRA attacks), insurance cover for damage and loss caused by terrorist actions – Terrorism cover became unavailable Pool Re functions as a reinsurance company Government provides reinsurance to Pool Re. Premiums paid into Pool Re and accumulate – £100,000 deductible – Government funds have not yet been tapped Other countries with govt-sponsored terrorism coverage or reinsurance: Australia, Austria, France, Germany, Israel, South Africa, Spain Slide 11
TRIA results - 1 Estimates were $15 bn lost construction one year after 9/11 (Real Estate Roundtable survey). – lack of insurance coverage and banks refusing to lend – TRIA passed Nov. 2002 and fixed this problem In economics, we called this a market failure – Government action can rectify such failures – Commercial construction was up 5.7% year-over-year in September
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TRIA results - 2 Glenn Hubbard (former head of Council of Economic Advisors for Bush) estimates that without TRIA: – Lose $53bn, or about 0.5% of total output (GDP) – 326,000 less jobs
Source: Glenn Hubbard & Bruce Deal, “The Economic Effects of Federal Participation in Terrorism Risk,” Analysis Group, Sept. 14, 2004.
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Estimates of premiums for terrorism insurance plus cost of self-insuring range from $1 billion to $10 billion ($10 billion estimate from Insurance Information Institute) Gain for the economy = $40 bn from TRIA
Conclusions Terrorism cannot be insured by the insurance industry alone, maximum loss is too large. Government involvement is required. TRIA is cost-effective TRIA is not particularly generous to the insurance industry — Pool Re in UK is more generous (eg. lower deductibles) Conclusion: TRIA should be renewed, with the addition of Group Life as is currently being proposed.
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