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Managing Terrorism Risk: Strategies and Challenges in Insuring Potentially Catastrophic Events

Explore the complexities of insuring terrorism risk, including the challenges in estimating potential losses and utilizing tools like underwriting and exposure management. Discover the limited capacity in the insurance industry, the need for innovative solutions from capital markets, and the importance of government involvement. Learn about the design principles for effective terrorism risk management that balance economic security and private market incentives while minimizing administrative burden and subsidies.

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Managing Terrorism Risk: Strategies and Challenges in Insuring Potentially Catastrophic Events

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  1. Eric Brosius May 7, 2007 Managing Terrorism Risk

  2. It’s all about capacity! • US insured property is roughly $30 trillion • WC fatality exposure is roughly $30 trillion • US insurer surplus is less than $1 trillion What promises to pay can we make? • Insurance is based on the ability to write large numbers of uncorrelated risks

  3. Managing catastrophe exposures • A catastrophe affects multiple risks, violating the condition that risks are uncorrelated. • To manage catastrophes, we use • Footprints of potential events • Detailed exposure data for the insured book • Realistic disaster scenarios and/or probabilistic modeling to project how event footprints will affect the book

  4. Why is terrorism risk hard to insure? • It is not fortuitous; probabilistic methods may not apply • It is catastrophic, and footprints are hard to predict • We don’t know what geographic areas or segments of the economy may be targeted • Potential losses are huge (could be $trillions) • We cannot estimate prospective expected loss

  5. Nuclear/biological/chemical/radiological (NBCR) events • Even harder to envision footprints • Generate even larger loss scenarios • More likely to be correlated with investment results • Reinsurance available only at “make me move” prices Destructive agency not as important as the size and nature of potential losses

  6. Tools for managing terrorism risk • Underwriting (know what you write) • Exposure management (know how much you write and where) • Bear risk consciously • Mitigate loss where feasible Insurers have only partial control over acceptance of risk, especially for WC

  7. Other sources of capacity • Traditional reinsurance • $6-8 billion estimated conventional capacity • Capital Markets • Available at a price, but will take time to become meaningful • Government • Essential for the foreseeable future

  8. Terrorism risk management design principles • Promote economic security • Encourage private market solutions • Maintain loss mitigation incentives • Minimize administrative burden • Limit subsidization (e.g., via surcharges) • Ask government to do what private market cannot

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