by Gedion Amesias and Jeri Xu
Is it possible to assess terrorism risk for underwriting insurance? This year alone there have been numerous terrorist attacks across the world. And although it may feel like terrorism is a constant threat, when it comes to evaluating the risk of terrorism for property insurance, lack of historical experience is one of the biggest challenges to accurately estimating the expected loss. The reason is that the majority of terrorists focus on how to maximize the number of casualties, rather than property damage, in order to garner the most media attention. As a result, there have been a relatively small number of events with large property losses.
As property underwriters, we always take into consideration terrorism risk because the majority of our reinsurance contracts include some type of terrorism coverage: domestic (homegrown) and/or foreign attacks, personal and/or commercial property. In May, a few of us from Swiss Re's US property treaty hub attended the RMS Terrorism Risk seminar, held over a half day in New York. RMS had a packed agenda with six sessions and both internal and external speakers. We found the session about terrorism risk modeling most intriguing because unlike the natural perils, terrorism risk is created by humans and isn't based on science. Modeling terrorism is essentially trying to predict human behavior. RMS released their first terrorism model back in 2002 and the chief architect of their model, Gordon Woo, gave a talk about the principles behind probabilistic terrorism modeling.
Terrorists seek media attention, which means they generally go for internationally well-known locations and where they can cause the most casualties. Dr. Woo disagrees with the "heartland theory", which is the belief that terrorism can happen in small towns in the middle of nowhere, so anyone anywhere should fear the risk of a terrorist attack. In modeling terrorism, we can allocate the distribution of risk based on how populous and how well known the location is.
Since 9/11, the US government and four of its allies (Five Eyes alliance) have been spending tens of billions of dollars each year on counter-terrorism. Even though it's hard to accurately estimate, there are experts that approximate the US spends around $100 billion a year on counter-terrorism efforts. Successful attacks since 9/11 have been carried out by either a lone wolf or a duo, for example the 2016 cargo truck attack in Nice by one driver, and 2013 Boston Marathon bombing by a pair of brothers. Plots that involve more people are more likely to be discovered through the surveillance of their communications, so organized large-scale plots are less likely to occur. Terrorism insurance is effectively insurance against the failure of counter-terrorism. Because counter-terrorism efforts have increased so much post 9/11, a reasonable assumption to make is that the frequency and severity of loss from terrorism have decreased significantly.
Because terrorism is a deliberate act that is controlled by humans, the threat changes depending on the sociopolitical climate. As underwriters, we tend to use historical experience to evaluate prospective losses, but because the terrorism landscape is ever shifting, we can't simply assume that the past is indicative of the future. We need to think about how terrorists will behave going forward and how governments around the world will counteract terrorism in order to predict where and to what extent future losses may occur.
Location: New York, NY, United States