Report: Private Markets Not Prepared to Cover Major Terrorism Losses

In a report on the insurance industry's ability to handle terrorism-related losses, the Organization for Economic Co-operation and Development warned that while terrorism insurance markets have improved since the Sept. 11, 2001 catastrophe, "there are continuing shortfalls in coverage," and private markets are still not prepared to cover "extremely large losses" that could yet occur.

The 290-page report, "Terrorism Risk Insurance in OECD Countries," said that estimated maximum losses from a single large terrorist attack range from $50 billion to $250 billion. "The losses associated with very large-scale terrorist attacks can remain beyond the capability of the private insurance and reinsurance industry to price and absorb alone," the report said.

In some OECD countries, a "mega terrorism" event could result in losses exceeding the joint compensation capacity of both private markets and governments to compensate "without threatening national economic stability." Given that, it may be necessary for some form of cooperative agreements between countries in the future, the OECD said.

The report found terrorism insurance take-up rates are low in a variety of countries. At year-end 2004, about half of companies in the United States were insured, and less than 3% of eligible firms had contracted with Germany's terrorism compensation plan. "Under these circumstances, the economic and social impact of a new large-scale attack could be greater than in 2001," the report said. "OECD countries concerned should develop risk awareness and could consider incentives to extend coverage and increase the financial capacity of terrorism risk compensation mechanisms."

The OECD noted that while chemical, biological, radiological and nuclear terrorism risks are generally excluded from insurance coverage and are not always fully covered through existing government-backed insurance plans, "governments should work with the insurance industry to find sustainable solutions for coverage."

Terrorism is still a thorny issue for insurance markets, since it is highly unpredictable and more difficult to cover than other types of catastrophes, the OECD said. Risk modeling has improved for terrorism, but still "falls short of making the likelihood of future attacks more predictable," the report said.

While financial markets may provide some additional capacity for terrorism risk, so far they have not shown much willingness to do so, according to the OECD.

While the OECD advises member countries to "rely as much as possible" on private insurance markets for terrorism coverage, the group added that "government intervention may be needed to increase -- or maintain -- terrorism insurance availability at an affordable price, where private markets lack capacity."

One way governments can help is by making changes in the tax and accounting environments to reduce the cost to the insurer of building up reserves to cover future catastrophic losses. Governments also can promote the development of alternative risk transfer strategies, the OECD said.

The report gave a nod to public-private partnerships such as those established in Australia, France, Germany, the Netherlands, Spain, the United Kingdom and the United States as successful efforts to stabilize the insurance markets following large-scale or frequent attacks. The report suggests a "layered approach" to terrorism risk coverage, involving insureds, insurers, reinsurance, a coinsurance or reinsurance pool, and the government as a last resort, could successfully mitigate the risks.

The OECD report was published just days after a much-anticipated U.S. Treasury report recommended the U.S. Terrorism Risk Insurance Act not be renewed in its present form once it expires at the end of this year. TRIA, passed by the U.S. Congress in response to the Sept. 11 catastrophe, set up a formula under which the U.S. government acted as ultimate backstop to any future terrorism losses suffered by insurers and insureds above a certain amount.

According to the U.S. Treasury, TRIA served its purpose in stabilizing shaken property/casualty markets after the attack, but has since distorted market forces by slowing private-sector development of terrorism coverage and lulling those buying insurance into complacency regarding their own risk management strategies (BestWire, June 30, 2005).

It is still uncertain whether Congress will heed Treasury's advice and refuse to renew TRIA.

The OECD is a coalition of 30 member countries dedicated to democratic institutions and a market economy. Members include 22 European states, Japan, South Korea, Australia, New Zealand, the United States, Canada, Mexico and Turkey.