Kurt Karl Presentation Dec 0704

Slide 1

The Cost of Terrorism: Insurance issues and TRIA

Kurt KarlSwiss ReEconomic Research & Consulting

GlobalInterdependenceCenter Conference Dec., 2004

Slide 2

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 3

Total International Terrorist Attacks: Frequency is trending downward

0

100

200

300

400

500

600

700

1982 1987 1992 1997 2002Terrorism Column 2

Source: Patterns of Global Terrorism, US State Dept.

Number All of decline from 2001 to 2002 due to Latin America

Slide 4

Insured catastrophic terrorism losses 1970–2003: Severity is up

0

5000

10000

15000

20000

1970 1975 1980 1985 1990 1995 2000Terrorism losses Column 2

Source: Swiss Re, sigma No. 1/2004

Property and business interruptionUSD mn, at 2003 prices

Slide 5

Property30%

Other Liability12%

Life3%

Business Interruption

33%

Event Cancellation

3%

Workers' Comp6%

Aviation Hull2%

Aviation Liability11%

9/11 consensus loss estimates: $32.5 billion in total

Source: Insurance Information Institute (III)

Slide 6

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

The insurance industry

Slide 7

143

17 132

42

Personal lines

Financial +A&H lines

Commerciallines

Reinsurers *

*) excluding National IndemnitySources: A.M.Best, Swiss Re Economic Research & Consulting

Distribution of P&C capital matters…

Surplus 12/2003$330.5 billion *

US P&C surplusin $ billions

segmented by dominate business lines

$132 surplus back comml’ lines that are covered by TRIA

Covered by TRIA

Slide 8

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

– State governments might impose restrictions on coverage and rates

– Difficult to spread risks across large base of buyers

Is terrorism insurable? - 1

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 9

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)

Excessive adverse selection, only terrorist targets want insurance.

Difficult to diversify the losses since terrorist actions can be co-ordinated throughout the world. Risks correlated.

The business is probably not economically feasible

Hence, there would be little insurance capacity provided

Is terrorism insurable? - 2

Sources: Swiss Re, “Insuring the uninsurable,” sigma 1/2005, forthcoming.

Slide 10

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 11

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 12

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 13

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

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

TRIA results - 2

Source: Glenn Hubbard & Bruce Deal, “The Economic Effects of Federal Participation in Terrorism Risk,” Analysis Group, Sept. 14, 2004.

Slide 14

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.

Conclusions

Slide 15

Comments & Questions

To be put on the mailing list for Swiss Re’s sigma contact: sigma@swissre.com

To be put on Swiss Re US Economic Outlook email list contact:kurt_karl@swissre.com

Download our sigma research from www.swissre.com/sigma