Kurt Karl Presentation Dec 0704

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

Slide 2

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

Slide 9

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

Slide 12

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.

Slide 13

 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.

Slide 14

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