January 30th, 2017

Public Sector Risk Financing Perspectives – Terror Risk: Part II

Posted at 1:00 AM ET

emma-karhan-smEmma Karhan, Managing Director

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The dynamic of pricing decrease and oversupply of capital has also been driven by the industry’s need to diversify into non-natural catastrophe lines of business in the current economic environment, and the fact that the terror market has a loss ratio of almost zero percent. In 2015, Swiss Re’s Sigma report calculated that 27 terrorist events resulted in 1082 fatalities, but no insured losses. Unlike other lines of business, recent pricing and capacity trends have not been driven by a better technical understanding of the impact of losses that normally translates into improved peril understanding or advances in pricing or modeling techniques. This has generally inhibited the industry from expanding its product base for terrorism in line with the evolution of the peril, concentrating more on supporting the pools and the current established bounds of insurable loss.

Terrorism is an evolving peril; its perpetrators previously focused on causing catastrophic losses such as those created by the attacks of September 11, 2001, that caused loss of life, widespread fear and community division. Now, terror groups such as DAESH (ISIL) are focusing on causing significant economic losses and long-term disruption through their terror attacks. The 2016 terror attacks in Brussels for example targeted major infrastructure components, while the 2016 Paris attacks struck at key aspects of Western culture such as restaurants, bars and music venues, each causing major financial disruption past the initial areas of impact.

Over the last 35 years, the gap between insured losses and uninsured losses has been increasing. Thirty-five years ago, economies were driven by the “physical world” - focused on primary and secondary losses; the proximate cause of any loss (including terrorism) was immediate and close. The current “fourth” industrial revolution (1) reflects a more service-driven economy, which is more about the “intangible” or non-physical losses. However, the (re)insurance industry still focuses on physical triggers for economic-driven losses and looks to insure huge concentrations of risk rather than looking at the far reaching insurable bounds of impact by losses in a service driven economy. Potential economic losses resulting from physical triggers are growing faster than levels of insured risk because of the increasing interconnectivity and contingencies between various sectors of the world’s economies.

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This is evident in the recent Brussels terror attacks - 85 percent of the current loss estimate is attributed to non- physical damage elements; material damage is only 12 percent of the loss. The loss estimate does not include the attacks’ impact of reducing area business activity levels - the drop in tourists and business travelers and reduced foot traffic for retailers and commercial businesses in the city.

Link to Part I>>

Link to Part III>>

Link to Part IV>>

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Note:

1. Klaus Schwab: The Fourth Industrial Revolution; World Economic Forum, 2016.

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