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Managing Terrorism Risk

Eric Brosius May 7, 2007. Managing Terrorism Risk. 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?

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Managing Terrorism Risk

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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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