January 15th, 2013

Terrorism Solutions: Modeling

Posted at 1:00 AM ET

David Flandro, Global Head of Business Intelligence, Julian Alovisi, Assistant Vice President, Lucy Dalimonte, Senior Vice President, Ellen Rieder, Managing Director and Emma Karhan, Senior Vice President

To support the process of managing and underwriting the terrorism peril, (re)insurers are increasingly using data management and modeling tools to analyze the risk. The dynamic nature of terrorism and the uncertainty in identifying the targets and frequency of attacks requires a specialized approach to manage the risk.

Modeling methodologies for terrorism have been continually refined and updated since the three major modeling companies - AIR Worldwide, EQECAT and Risk Management Solutions (RMS) - released their first terrorism models in 2002. Quantifying the economic, insured and human losses from a terrorist attack continues to pose major challenges for (re)insurers. There are three main techniques to model terrorism risk:

  • Probabilistic modeling estimates losses based on a large number of events. A key factor is the estimated frequency a modeler applies to all the possible events that could occur. Due to the difficulty in predicting the probability of terror events, there is considerable uncertainty associated with probabilistic terrorism modeling.
  • Exposure concentration analysis identifies and quantifies concentrations of exposures around potential terrorist targets. Target-based accumulation assessment locates potential targets (typically with high economic, human and/or symbolic value) and aggregates an insurer’s exposures in and around various distances from these targets.
  • Deterministic modeling represents a compromise between the lack of accuracy in accumulation analysis and the uncertainty surrounding probabilistic models. By imposing an actual event’s damage “footprint” at a specified target, a specific, yet hypothetical, scenario can be analyzed with some certainty. Major modeling firms offer an array of deterministic-analysis tools for conventional and nuclear, biological, radiological or chemical instruments attacks at defined target and non-target locations.

Compared to natural hazards such as hurricanes and earthquakes, terrorism modeling is still in its infancy. Insurers, reinsurers and modeling companies are constantly refining their models and the assumptions that underlay their products, thereby increasing their ability to manage terrorism risk in an educated and more quantitative fashion. Currently, deterministic, scenario-based testing is the most common tool used by (re)insurers to assess their vulnerability to terrorism.

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