August 16th, 2011

Terrorism Market Continues to Provide Abundant Cover

Posted at 1:00 AM ET

David Flandro, Global Head of Business Intelligence, Paul Knutson, Managing Director, Emil Metropoulos, Senior Vice Present, Julian Alovisi, Assistant Vice President

Nearly a decade has passed since the September 11, 2001, attacks, and terrorism continues to pose a serious risk to the (re)insurance industry. The nature of the transnational threat has changed significantly since 2001. Developments over the last 12 months, including the killing of al-Qaeda leader Osama bin Laden and the political unrest in the Middle East and North Africa, raise important questions about the future of the international terrorist threat. However, global recorded terror incidents remain at historically high levels. New al-Qaeda affiliated groups in unstable countries have emerged, such as al-Qaeda in the Arabian Peninsula (AQAP) in Yemen. And, as demonstrated by the recent twin terror attacks in Norway, the risk posed by domestic militant groups means terrorism is likely to remain a global security threat for the foreseeable future.

Despite the changing nature of the terrorist threat and its unpredictability, the reinsurance industry, along with the myriad local government terror pools, continues to successfully provide adequate terror cover. The terrorism reinsurance market has undergone significant change since it peaked in 2002-2004. The absence of major terror losses in subsequent years saw capacity increase, creating supply and demand imbalances and prompting a general decline in global terrorism-specific reinsurance pricing.

Supply remains abundant, with Guy Carpenter estimating between USD6 billion and USD8 billion of terrorism capacity currently available in the US market. However, a portion of that capacity remains unclaimed, as much of the US terror risk resides in the program originally created by the Terrorism Risk Insurance Act of 2002 (TRIA), which provides a governmental backstop for terror loss but does not purchase reinsurance. Globally, major terror pools currently consume approximately USD9 billion of capacity, yet up to USD2 billion excess capacity was authorized but not signed to those pools in 2011. Despite this, terror reinsurance pricing has recently shifted to a flattening price environment after years of downward movement. The reinsurance industry reacted to its depleted capital positions following the heavy natural catastrophic loss activity over the last 18 months. Both the property catastrophe and terrorism markets are characterized by low-frequency, high-severity exposures. Since reinsurers pay all types of low-frequency, high-severity catastrophic claims from the same pool of available capital, the recent natural catastrophe losses and industry capital decrease have eased the downward pressure on terrorism pricing.

For now, reinsurers expect that their overall appetite and available capacity for terrorism will be steady as we move into 2012, especially with respect to global terror pools. Even so, most reinsurers will formalize their 2012 business plans in the second half of 2011 in light of their current capital levels. Much will depend on loss experience for the remainder of this year, but barring further significant capital depletion, the over-supply of terrorism reinsurance globally is expected to stifle price increases in terrorism even if other lines experience upward pressures.

Yet the market remains vulnerable to a major terrorism loss. The future of TRIA and the Terrorism Risk Insurance Reauthorization and Extension Act of 2007 (TRIPRA) in the United States is also important. Although the Obama administration now looks less likely to cut federal support for the pool, any unforeseen change of policy has the potential to turn the US terrorism reinsurance market and shift the global landscape towards a tighter market.

Global terrorism has had a profound impact on the (re)insurance market over the past decade. As we approach the tenth anniversary of the catastrophic events of September 11, 2001, the terrorism landscape has changed dramatically. Although the nature of the threat is very different today from what it was 10 years ago, terrorism remains a constant and serious threat. Global recorded terror incidents are at elevated levels as international militants continue to target countries around the world. The complexity of the risk remains, especially internationally, as individuals and groups affiliated with al-Qaeda continue to plan attacks. The bombing and shooting attacks in Norway’s capital of Oslo in July also emphasize the serious and continued threat posed by domestic individuals and groups.

The terrorism threat is forever evolving as groups adapt their tactics to counter-terrorism measures and global events. Indeed, key developments that have occurred over the past 12 months, including the killing of al-Qaeda leader Osama bin Laden and the recent political unrest in the Middle East and North Africa, raise important questions about the future of the international terrorist threat. For insurers with terrorism risk on their books, it is important to understand how the terrorism threat is evolving, the varying risks in different regions and what developments are likely in 2011 and beyond.

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