Terrorism risk still looms large

Apart perhaps from the recent failed bomb attack in New York’s Times Square, the prospect of a terrorist attack seems to have faded. But there is no room for complacency. This was the view taken by the recent OECD Conference on Terrorism Insurance in Paris, where Swiss Re called for increased efforts to implement best practice solutions around globe.

The best practice principles and recommendations as expressed in the 2005 OECD report on terrorism insurance remain relevant and state-of-the-art. The OECD conference confirmed this fact. But what has changed since the report was released?

For Swiss Re not much, other than a general market softening combined with a stronger preparedness to provide cover against terrorism. These changes are, in our view, largely market-cycle driven and have been given added momentum by the absence of any larger terrorism attacks. This is not a result of a fundamental change in the risk landscape or the development of new cover concepts or products. Although the comfort level has considerably increased, the situation still remains relatively fragile and could deteriorate rapidly  if there were a major incident.

Public-private partnerships

It is widely acknowledged that a public-private partnership approach is essential to guarantee sustainable and robust solutions. Governments' main responsibility lies in the prevention and mitigation of terror attacks as well as in the definition of a suitable regulatory framework within which to operate. The insurance industry, on the other hand, manages the risk transfer and financial impact of such attacks up to certain limits, beyond which governments might need to step in again.

The terrorism risk is difficult to weigh and insure.  The most efficient way to provide cover is to follow these principles:

• Separate terrorism coverage from other insurance covers/perils so that the risk becomes fully transparent and does not "pollute" other exposures in bundled covers.
• Channel all terrorism policies into a pool type of facility (private, or state-run)
• Cap the maximum pay-out per event and year to avoid a potentially unlimited downside
• Pro-rate pay-outs, if claims exceed such a cap, or use a Government entity as a last resort

Such an approach makes best use of the scarce and costly capital that is required to cover the terrorism risk. It also is most efficient in respect of assessing the risk and monitoring terrorism accumulations. At the conference it was also reiterated that the existence of a TRIPRA type of mechanism (Terrorism Risk Insurance Program Reauthorization Act) is paramount for the continued provision of terrorism cover by the private markets in the US.

When comparing the insurance costs of state-run pools to privately managed pools, proper consideration of tax exemptions is crucial. The OECD conference also called for the European anti-competition law to be applied with some meaningful leeway to terrorism pools to encourage the development of desirable insurance solutions that could be in the interest of the public and consumers.

For more on what countries should do on terrorism coverage, see the 'Further reading' box at the right.