By JACK SEAQUIST, assistant vice president, AIR Worldwide Corp.
With the passage of the Terrorism Risk Insurance Program Reauthorization Act of 2007 (TRIP), the federal government extended the its terrorism insurance program for seven years, through 2014. This gave insurers the sense of stability needed for a viable market. Coverage for conventional terrorism has been made available at prices sufficiently reasonable for take-up rates to have grown and stabilized, particularly in areas perceived to be at high risk.
Overall, commercial property policies vary in the application of exclusions and vary across states. Also, different insurers may implement exclusions with different language and in different combinations.
Pollution exclusions typically exclude coverage for release of contaminants that harm individuals and property. There may be exceptions in place to provide coverage for a specified cause of loss, such as those emanating from certain vehicle types. The pollution exclusion may be an issue in the event biological and chemical agents are used in a terrorist attack.
The virus and biological exclusion applies to any virus, bacteria, or microorganism that induces or is capable of inducing physical distress, illness, or disease. This may be an issue in the event of biological attacks such as anthrax.
While take-up of terrorism insurance coverage is an option for commercial policyholders under the current Terrorism Risk Insurance Program, certain policyholders receive some coverage even if they decline terrorism coverage. For property coverage, it is standard for insurers to be required to cover losses from fire following an event, regardless of the cause of the fire. This appears to be the case in such large states as New York, California, Illinois, New Jersey, Massachusetts, as well as several other states. For nuclear bombs and radiological dirty bombs, the same fire coverage provided to those who take up terrorism coverage can apply to those that decline.
For typical property coverages, the nuclear hazard exclusion excludes radiation and radioactive contamination. Thermal radiation from a nuclear bomb blast causes extensive burning in the area affected by the force of the bomb blast. Claims for these fire damages can be expected after such an event. Radiation and fallout contamination, which is likely to extend over a very wide area, may not be covered. A radiological dirty bomb uses a very small explosive to spread such radiation and contamination. Related blast damages would be minimal.
For conventional bomb attacks in such states, any residual fire or intentional fire damage (depending on the specific bomb characteristics) would also be covered.
Fire coverage has become a prominent issue since the Islamabad Marriott Hotel bombing in September 2008, during which terrorists used enhanced firebombing techniques to overcome a high security level environment. This caused heavy fire damage to the hotel.
A similar attack in the United States would likely be covered in one of the aforementioned states, even if the policyholder had declined terrorism coverage.
Workers' compensation insurance for terrorism losses is much less complex: there are no terrorism-related exclusions for injuries and fatalities resulting from being at work. Workers' compensation insurers can expect to be subject to the potential losses from terrorists' use of conventional or CBRN weapons.
For CBRN property coverage, the Government Accountability Office (GAO) reported in December 2008 that coverage has been scant because of very limited availability and rates that are deemed to be too expensive. The agency found that insurers were not inclined to offer coverage for such potentially large catastrophic losses. Scenarios reported by the American Academy of Actuaries to the President's Working Group on Financial Markets (based on the AIR terrorism model) indicate that industry losses for a single CBRN event in New York could exceed $775 billion, which would surpass the combined industry surplus of the U.S. property/casualty industry.
Nonetheless, there is a need for policyholders to manage the risk of large-scale terrorist attacks. Some are seeking coverage, and, given the current economic slowdown, the industry is beginning to develop offerings designed to meet the demand. These have taken multiple forms, including:
--Stand-alone policies that provide terrorism coverage that may limit or eliminate exclusions but with possibly lower limits
--Specialized coverage that fills gaps, covering one or more attack types that are otherwise excluded in the policyholder's property policy
At this time, many consider a best practice for insurer terrorism risk management to be monitoring, limiting and managing accumulations of exposure either within a defined radius or with respect to modeled losses resulting from a single defined weapon, such as a conventional truck bomb. Expected recoveries from TRIP and reinsurance can extend insurers' capacity and limit their exposure. These measures are used by rating agencies to assess insurers' capital. The reinsurance participation, however, has not developed sufficiently, but that may be changing.
Historically, only a small amount of reinsurance capacity has been allocated to the terrorism insurance market--reportedly about $6 billion. Reinsurers covered conventional attacks but excluded CBRN completely. More recently, many insurers have changed their approach from offering a terrorism book separately to offering terrorism bundled with other catastrophe risk. Such an insurer is looking for a single price for the bundle, so the reinsurer must take on the terrorism risk in order to partake in the natural peril business. Again, commercial policies could include a mix of take-ups, exclusions and exposure to standard fire policies; workers compensation offers no exclusions.
In another recent development, the Obama administration, in its 2010 budget submission, has indicated a desire to scale back on TRIP by raising company deductibles and copayments over time and reintroducing the elimination of coverage for domestic attacks. It remains to be seen if this will result in legislation. If so, there will be more insurer exposure looking for reinsurance cover.
PERCEPTION OF TERRORISM RISK
The perception of terrorism insurance risk has changed since 9/11. No attacks have since occurred on U.S. soil. This has resulted in some complacency and a reduction in the perceived likelihood of a future attack. Also, there have been no claims against terrorism insurance coverage, thus creating accumulated profit for insurers and reinsurers. But what do we know about what is likely to occur in the future?
Unlike the case for natural catastrophes, where physical mechanisms are at play and understood by scientists, the insurance industry does not get detailed information about terrorism threats until they are either thwarted, the threat level is changed or an actual event occurs. Instead, we must rely on private-sector experts and official statements from the intelligence community.
Each year, the senior U.S. intelligence official issues an Annual Threat Assessment of the Intelligence Community to congressional committees. An unclassified version is available to the public. In 2009, Dennis C. Blair, director of national intelligence, stated the following:
"Because of the pressure we and our allies have put on al-Qaida's core leadership in Pakistan and the continued decline of al-Qaida's most prominent regional affiliate in Iraq, Al-Qa'ida today is less capable and effective than it was a year ago."
This is the first indication since Sept. 11 of a reduced threat. From a CBRN perspective, he stated:
"Al-Qaida is the terrorist group that historically has sought the broadest range of CBRN attack capabilities, and we assess that it would use any CBRN capability it acquires in an anti-U.S. attack, preferably against the homeland. There also is a threat of biological or chemical attacks in the U.S. homeland by lone individuals."
The intelligence community also perceives a reduced threat but is cautious about the ongoing threat of a CBRN attack at any time.
MODELING THE IMPACT
From a modeler's perspective, quantifying risk is particularly challenging when the risk is dynamic. Modeling terrorism risk requires continual monitoring of the terrorism insurance market and adapting to new complexities and a changing marketplace.
Exclusions, exceptions and special coverages must be addressed and applied to the method of attack and individual damage mechanisms.
Physical damage from blast, fire and various contaminants must be distinguished based on the potential for coverage, which, again, varies. Workers' compensation benefit levels must be updated to include the most recent regulations and claims experience. Frequency estimates used in a probabilistic model must be updated based on recent threat assessments.
But with all this input, models can be useful to insurers and reinsurers to:
--analyze concentrations of exposures and their proximity to likely targets
--examine the effects of attack scenarios that affect specific exposures
--perform fully probabilistic analyses for company-specific portfolios
--support pricing, portfolio management and overall risk management
--analyze correlations of estimated losses across multiple lines of business by event
--provide information to rating agencies
Terrorism is a complex peril, and the stakes are high. Modelers and market participants should be aware of the complexities and consider them appropriately.
October 1, 2009
Copyright 2009© LRP Publications