Terrorism risk insurance in OECD countries

290 Pages·2005·2.217 MB·English

by  OECD

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Who should compensate the losses stemming from new forms of terrorism? To what in

extent and under what conditions can insurers and reinsurers continue to cover this In Insurance in
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exposure? Could financial markets provide additional capacity ? Should governments
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Answers to these questions have gradually emerged in OECD countries since the

11 September 2001 attacks and are continuing to take shape. Several years after
these events, and while the renewal of government-backed terrorism compensation
schemes is being discussed in some of its member countries, the OECD reviews
market evolutions and existing national arrangements to cover terrorism exposures.
It also draws attention to several questions and concerns that remain unanswered.
This volume combines OECD policy conclusions with leading academic analysis
on a wide scope of issues related to the financial management of terrorism risk. It will
allow a better understanding of issues at stake as well as of market and regulatory
initiatives to meet the critical financial challenge raised by modern terrorism.
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No. 9 www.oecd.org
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No. 9
cover.fm Page 1 Wednesday, June 15, 2005 3:39 PM
Policy Issues in Insurance
Terrorism Risk
Insurance in
OECD Countries
No. 9
ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT
cover.fm Page 2 Wednesday, June 15, 2005 3:39 PM
ORGANISATION FOR ECONOMIC CO-OPERATION
AND DEVELOPMENT
The OECD is a unique forum where the governments of 30 democracies work together to address
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Organisation provides a setting where governments can compare policy experiences, seek answers to
common problems, identify good practice and work to co-ordinate domestic and international policies.
The OECD member countries are: Australia, Austria, Belgium, Canada, the Czech Republic, Denmark,
Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Korea, Luxembourg, Mexico, the
Netherlands, New Zealand, Norway, Poland, Portugal, the Slovak Republic, Spain, Sweden, Switzerland,
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part in the work of the OECD.
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research on economic, social and environmental issues, as well as the conventions, guidelines and
standards agreed by its members.
This work is published on the responsibility of the Secretary-General of the OECD. The
opinions expressed and arguments employed herein do not necessarily reflect the official
views of the Organisation or of the governments of its member countries.
Publié en français sous le titre:
Assurance du risque terroriste dans les pays de l’OCDE
N° 9
© OECD 2005
No reproduction, copy, transmission or translation of this publication may be made without written permission. Applications should be sent to OECD
Publishing: [email protected] or by fax [phone]. Permission to photocopy a portion of this work should be addressed to the Centre français
d'exploitation du droit de copie, 20, rue des Grands-Augustins, 75006 Paris, France ([email protected]).
Foreword
T
he terrorist attacks of 11 September 2001 took a terrible toll of human life and have changed
the course of history. Among other impacts, they were also the most costly disaster ever for the
insurance industry. Insurers and reinsurers reacted responsibly to the attacks by assuming their
part of the losses, demonstrating the crucial role that a well capitalised insurance sector can play
both to compensate losses after a major disaster and more generally to help economies run
smoothly. However, the 9/11 events fundamentally changed the perspective on future expected
losses from terrorist acts. Driven by the fear of further (and possibly imminent) large-scale
terrorist attacks, most insurers and reinsurers drastically reduced their exposure to terrorism risk,
revised the terms of their policies, and increased their premiums.
A few years have now passed without another terrorist act of a comparable magnitude, and the
terrorist insurance market has gradually relaxed. The tsunami which ravaged the coasts of
southern Asia on 26 December 2004, at the end of a record year for the cost of natural disasters,
came as a reminder of the diversity both of the catastrophic risks threatening our societies and the
priorities for action.
Nevertheless, the attacks on three railway stations in the Madrid suburbs on 11 March 2004 as
well as other terrorist acts and many foiled attempts, and the recurrent warnings of terrorism
experts all bear witness to the persistence of the terrorist threat, and the need to improve
preparedness and the response to terrorism.
In 2002, OECD Ministers asked the Organisation to help them to prepare for the financial
consequences of possible further large-scale attacks and to provide compensation for such
unforeseeable events. They requested “policy analysis and recommendations on how to define and
cover terrorism risks and to assess the respective roles of the insurance industry, financial markets
and governments, including for the coverage of “mega-terrorism” risks”1. In response to this
request, the Insurance and Private Pensions Committee set up a Task Force of government and
industry experts.
This volume compiles OECD policy conclusions2, and leading academic analysis on the financial
management of terrorism risk3, nearly four years after the World Trade Centre attacks. It seeks to
enhance understanding of the issues at stake and the options available to markets and
governments facing the challenge of compensation for modern terrorism.

The publication consists of three main parts, allowing different levels of reading:
• Part I : Summary of conclusions and policy options ;
• Part II: Analyses of the major policy issues raised by the mandate, i.e. the respective role
of the insurance industry, financial markets and governments in the coverage of terrorism risks,
and the case of mega-terrorism risk.
• Part III: Reports by the consultants to the OECD Task Force on Terrorism Insurance.
The first two Parts are published under the responsibility of the OECD Insurance and Private
Pensions Committee. The conclusions and policy options are not binding, and do not condition,
POLICY ISSUES IN INSURANCE No. 9: TERRORISM RISK INSURANCE IN OECD COUNTRIES – ISBN-92-64-00872-1 © OECD 2005
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– FOREWORD

compromise or prejudge measures adopted in several countries to compensate for losses resulting
from terrorism. The reports in Part III (and the annex on terrorism compensation schemes in
selected non-member countries) are written under the responsibility of their authors and the
opinions expressed therein are not necessarily those of the Insurance and Private Pensions
Committee, the Task Force on Terrorism Insurance, or the OECD member countries.
I would like to thank all those involved in this project. It was carried out under the aegis of the
Insurance and Private Pensions Committee and is built on the work and close cooperation of the
members of the Task Force on Terrorism Insurance. The project also benefited from the high
quality of the work and the expert input of the consultants to the Task Force. This publication was
produced under the direction of Cécile Vignial, Principal Administrator, Directorate for Financial
and Enterprise Affairs, with the cooperation of Alberto Monti, Professor at Bocconi University
(Italy) and technical support from Claire Dehouck and Edward Smiley.

Donald J. Johnston
Secretary-General

Notes

1 “We recognise the adverse effects of the shrinkage of affordable insurance cover for terrorism risks. We
would welcome OECD policy analysis and recommendations on how to define and cover terrorism risks
and to assess the respective roles of the insurance industry, financial markets and governments, including
for the coverage of “mega-terrorism” risks.” See OECD Council at Ministerial Level, 15-16 May 2002:
Final Communiqué.
2 Various other documents with a more focused approach have been discussed within the OECD Insurance
and Private Pensions Committee and its Task Force on terrorism insurance. The task of drawing up a list
of criteria to define terrorism for purposes of compensation is the subject of a separate Recommendation
(see http://www.oecd.org/daf/insurance).
3 The reader’s attention is drawn to the fact that this publication deals almost exclusively with property
insurance.
POLICY ISSUES IN INSURANCE No. 9: TERRORISM RISK INSURANCE IN OECD COUNTRIES – ISBN-92-64-00872-1 © OECD 2005
Table of Contents

PART I
SUMMARY OF CONCLUSIONS AND POLICY OPTIONS
1. The new terrorism threat: a major challenge to the insurance world.............................................9
2. Towards sustainable policy options to cover unpredictable terrorism risks.................................13
PART II
POLICY ISSUES
Chapter 1 Insurability of Terrorism Risk.................................................................................................29
Introduction..........................................................................................................................................29
1. New terrorism threat, new challenges for the insurance industry.................................................29
2. Market reactions after the 9/11 attacks: from drastic shrinkage in affordable insurance cover
to the development of new insurability conditions.........................................................................34
3. Outstanding questions, and the need for sustainable solutions commensurate to modern
terrorism risks................................................................................................................................41
Conclusion............................................................................................................................................44
Chapter 2 Financial Market Solutions for Terrorism Risk......................................................................55
Introduction..........................................................................................................................................55
1. Available capital market solutions to cover terrorism risks..........................................................55
2. The challenge of terrorism risk securitisation...............................................................................58
Conclusion............................................................................................................................................61
Chapter 3 Possible Role Of Government In The Coverage of Terrorism Risk.........................................67
Introduction..........................................................................................................................................67
1. Possible forms of government intervention in the terrorism insurance market,
their advantages and drawbacks..................................................................................................68
2. The OECD countries’ terrorism compensation schemes: some lessons to be drawn....................72
3. National vs. international solutions...............................................................................................77
Conclusion............................................................................................................................................78
Chapter 4 Compensation of Mega-Terrorism Risk..................................................................................87
Chapter 5 Terrorism Insurance Schemes in OECD Countries (2005): omparative Tables.....................93
Terrorism Insurance schemes in OECD countries (2005)...................................................................94
Definitions of terrorism acts for the purpose of compensation in OECD countries...........................101
PART III
REPORTS BY THE EXPERTS TO THE OECD TASK FORCE ON TERRORISM INSURANCE
Chapter 6 Insurability of (Mega-) Terrorism Risk : Challenges and Perspectives, by H. Kunreuther
and E. Michel-Kerjan.............................................................................................................107
1. Introduction.................................................................................................................................108
POLICY ISSUES IN INSURANCE No. 9: TERRORISM RISK INSURANCE IN OECD COUNTRIES – ISBN-92-64-00872-1 © OECD 2005
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– TABLE OF CONTENTS

2. New Frontiers..............................................................................................................................108
3. Insurability Of Extreme Events: Why Is Terrorism Different?....................................................114
4. Covering Mega-Terrorism: The Need For Public-Private Partnerships....................................123
5. Modeling Terrorism Risk.............................................................................................................131
6. Conclusion and Open Questions.................................................................................................138
References...........................................................................................................................................143
Appendix.............................................................................................................................................148
Chapter 7 International Financing Solutions to Terrorism Risk Exposures, by T.J. Andersen.............149
1. Introduction.................................................................................................................................150
2. Forms of Market Intervention......................................................................................................153
3. Other Compensation Mechanisms...............................................................................................170
4. Alternative Risk Management Solutions......................................................................................176
5. Summary and Conclusions..........................................................................................................180
References...........................................................................................................................................185
Chapter 8 The Role of Government in the Coverage of Terrorism Risks, by D. Jaffee..........................189
1. Introduction and Agenda; Executive Summary...........................................................................190
2. The Failure of Private Insurance Markets for Catastrophic Risks..............................................198
3. Modalities for Government Intervention In Terrorism Insurance Markets.................................204
4. Limits and Drawbacks to Government Intervention in Terrorism Insurance Markets................213
5. Policy Proposals..........................................................................................................................216
References...........................................................................................................................................226
Chapter 9 The Coverage of Terrorism Risks at National Level, by J. Cooke.........................................231
1. Introduction.................................................................................................................................232
2. Main Features of Terrorism Acts Covered..................................................................................233
3. Terrorism Insurance in OECD Countries...................................................................................234
4. Specific Schemes for Terrorism Insurance in OECD Countries..................................................238
5. Good Practice – in Theory and Practice.....................................................................................264
6. Conclusion...................................................................................................................................270
Notes...................................................................................................................................................272
References...........................................................................................................................................272
ANNEX
Terrorism Coverage in Selected Non-Member Countries, by A. Monti.................................................277
Introduction........................................................................................................................................277
1. The South African Experience: SASRIA......................................................................................277
2. The Israeli compensation system.................................................................................................280
3. The Indian Terrorism Risk Insurance Pool.................................................................................285
Conclusions........................................................................................................................................286

POLICY ISSUES IN INSURANCE No. 9: TERRORISM RISK INSURANCE IN OECD COUNTRIES – ISBN-92-64-00872-1 © OECD 2005
Part I
Summary of Conclusions and Policy Options
POLICY ISSUES IN INSURANCE No. 9: TERRORISM RISK INSURANCE IN OECD COUNTRIES – ISBN-92-64-00872-1 © OECD 2005

Summary of Conclusions and Policy Options*

1. The new terrorism threat: a major challenge to the insurance world
1.1. The changing nature of international terrorism risk, as demonstrated in
particular by the September 2001 attacks in the United States, translates into a
tremendous and potentially lasting threat against which no country can claim to be
protected. It calls for greater co-operation on an international scale. If loss prevention
and mitigation perform a crucial function in terrorism risk management strategies,
ensuring sustainable financial coverage of the terrorism risk1, if prevention were to
fail, is a no less important policy issue to mitigate the potentially devastating impacts of
future attacks and to facilitate recovery.
Looking back at the historical record of small and large national and international terrorism
acts committed over the last 30 years, terrorism was certainly not an unknown exposure before
2001. The increasing severity of terrorism acts, especially during the 1990s, was a rising source of
concern. The damaging potential of terrorists and the urgency of a radical change in terrorism risk
management remained, however, largely underestimated prior to the September 11 attacks in the
United States.
On 11 September 2001, two aircraft hit the NYC World Trade Centre Twin Towers, while
almost simultaneously another one hit the Pentagon and a fourth aircraft crashed in Pennsylvania.
These attacks marked the advent of a new form of terrorism characterised by an unprecedented
loss dimension, a transnational nature and much broader geographical scope. The attacks caused
insured losses currently estimated at more than USD 30 billion, making them the single most
costly event ever recorded in the history of the insurance and reinsurance industry, and changed
the general perspective on the future expected losses and impact of terrorist attacks. Terrorism has
become a worldwide issue, against which no country can claim to be protected. It has also become
far more difficult to predict, detect and effectively prevent.
This new threat calls for co-ordinated action on an international scale. Gaining a proper
understanding of what constitutes terrorism in the 21st century, and enforcing a strong and
comprehensive multinational counter-terrorism policy are certainly important steps to be taken at
this stage. Educating society, increasing public awareness of potential attacks, and preparing
emergency and rescue plans are other fundamental policy goals to be pursued. If loss prevention
and mitigation are crucial in terrorism risk management strategies, it is no less essential to provide
compensation so as to permit rapid recovery if prevention were to fail. Given the potentially
devastating impact of future attacks, this has become an important policy issue in OECD
countries.
1.2. Before 2001, terrorism risk was widely considered by insurers to be a manageable
exposure, and private non-life insurance routinely covered most terrorism risks related
to property loss.
Private insurance used to cover most terrorism risks related to property and casualty loss,
generally under fire policies which would provide compensation for fire and explosion damage of

* References to the sources to which this summary is indebted are to be found in the detailed notes in Part II
Chapters 1, 2, 3 and 4, infra.
POLICY ISSUES IN INSURANCE No. 9: TERRORISM RISK INSURANCE IN OECD COUNTRIES – ISBN-92-64-00872-1 © OECD 2005