Actuaries reportedly face difficult challenges in accurately pricing commercial property insurance coverage under the Terrorism Risk Insurance Act of 2002 (TRIA), the temporary federal financial backstop for insuring against terrorist attacks approved by Congress last November.
Reinsurance and exposure modeling experts updated insurance actuaries on TRIA, which expires Dec. 31, 2005, at the Casualty Actuarial Society’s annual meeting in New Orleans recently.
Under TRIA, “it’s very important to Congress that we (the property and casualty insurance industry) come up with reasonable, predictable prices (for terrorism coverage) and that’s very much within the role of the actuary,” said Christopher Yaure, risk manager, Terrorism and Emerging Risks for Employers Reinsurance Corporation.
Insurance companies are built around ways to make valid statistical estimates, but are not out there to “crystal ball things,” he noted. Yet insurers have to come up with a price for terrorism coverage and be able to justify it to regulators, insureds and reinsurers.
TRIA is a temporary federal program, Yaure reminded the actuaries, and pointed out that whether something new replaces it, it will not stay as it is. It allows for a transitional period for the private insurance market, he said.
An act of terrorism as defined in TRIA is:
· Violent act or act dangerous to human life, property or infrastructure;
· Damage in the U.S.
Applies outside of the U.S. for certain air carriers, vessels and missions
· On behalf of an foreign person or interest;
· Effort to coerce the civilian population or influence the policy or affect the conduct of the government by coercion.
There are all sorts of potential gray issues in the federal government’s application of TRIA standards, the reinsurance company official said. “Are they going to try to find that something is not an act of terrorism so they don’t have to compensate the insurance companies for their losses, or are they gong to find that it is an act of terrorism to be sure that more insureds are covered?” asked Laure.
TRIA doesn’t apply to acts committed as part of declared war, with an exception for workers’ compensation, and aggregate losses of $5 million or less.
The Secretary of the Treasury certifies whether an act is one of terrorism and that determination is final and not subject to judicial review, thus limiting the involvement of lawyers, he said.
For property and casualty insurers, TRIA applies only to commercial lines and specifically includes excess insurance, workers’ compensation and surety. It excludes a number of lines, including crop or livestock insurance, medical malpractice, the national flood insurance program and reinsurance.
Insurers have to make available coverage for losses from acts of terrorism, either as part of their policies or through separate policies, and the coverage cannot differ materially from the terms, amounts and other coverage limitations that apply to losses from events other than acts of terrorism, said Yaure. But if insurers want to exclude coverage for nuclear, radiological, biological or chemical incidents regardless of cause, they can exclude them for acts of terrorism, he noted. “The key is they can exclude a cause of loss, but can’t exclude that cause of loss just for terrorism,” he emphasized.
Federal compensation to insurers for acts of terrorism is 90 percent of insured losses in excess of a deductible, with a formula and rules to determine the amount of that deductible.
Yaure told the actuaries there are caps on liability and disclosure requirements, as well as state and federal reporting requirements under TRIA. But probably the most important thing, he said, is how to get to a number that tells us what a terrorism risk is worth. And that comes from the modeling approach to pricing terrorism risks, he concluded.
“In order to respond to the needs of TRIA, we needed an ability to price terrorism risks and to identify what the loss costs would be for particular policies,” said David Lalonde, senior vice president at the insurance modeling firm of Applied Insurance Research. Terrorism insurance modeling is needed to be able to better anticipate and understand reinsurance needs and to demonstrate good risk management practices to insureds, as well as to insurance company shareholders, he said.
AIR used its framework for modeling natural catastrophes to develop a terrorism model. And the modeling firm was able to utililize its existing industry exposure database and apply it to a detailed property database for locations within the U.S. to develop such a model.
In modeling for TRIA, Lalonde said, we had to consider policy conditions to determine what’s included and what’s excluded. And it all comes down to the insured loss based on concentration of exposure and correlation of losses, he noted.
The key questions for terrorism modeling are reportedly who is going to commit the terrorist act, where are they going to do it, what kinds of weapons are they going to use, and the kinds of losses that could be expected – both in terms of total losses and insured losses.
“For each terrorist group, based on a review of their objectives, their history and possible countermeasures, expert opinion is used to assess and come up with a group threat index- first by looking at the target types, then looking at the probabilities of attacks on different locales and the different weapons at their disposal,” said the AIR official. “We came up with a database of 300,000 potential targets to ensure there is full coverage as to where possible acts might occur,” Lalonde said. Formulas were developed to project the likely frequency and severity by location.
In trying to determine potential insured losses, AIR can take a portfolio of exposures, simulate events and weight them with probabilities to come up with loss numbers, he said.
It’s up to each insurer to look at its exposure, however, to see how its risks are distributed and its potential exposure to terrorism risks, Lalonde cautioned.
“AIR’s terrorism model accounts for TRIA by being able to model the weapons types and terrorist group types separately in order to asses the potential losses from certified acts of terrorism,” Lalonde said. Insurance Services Office advisory loss costs are also available to insurers for territorial pricing and to determine how they impact an individual company’s book of business, he concluded.
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