The Threat Remains: With or Without TRIA, Terrorism Still a Top Concern

The insurance industry expressed its disappointment over the June 30 release of the Treasury Department’s report announcing its opposition to the renewal of the Terrorism Risk Insurance Act by Congress in its current form. TRIA is set to sunset on Dec. 31, 2005.

While the Treasury Department may have recommended not to renew TRIA, it is evident that the threat of another major terrorist attack is omnipresent, and that terrorism risk management will remain a priority for U.S. businesses.

A RAND Corporation study released June 20 revealed that the United States’ terrorism insurance system is failing to protect businesses by not providing adequate financial protection in the event of major terrorism event. The shortfalls in the system leave the nation susceptible to massive economic disruption should another event occur.

The study, released in conjunction with the National Symposium on the Future of Terrorism Risk Insurance at the University of Southern California in Los Angeles June 20, said that current U.S. insurance system is not strong enough to respond to a rapidly evolving terrorist threat to U.S. businesses.

TRIA’s sunset and the newly-released RAND study dominated at the symposium, and panelists discussed the possibility of TRIA’s extension, as well as changes that need to be made to the existing policy and in coverage. Also discussed were the terrorism threats currently faced by U.S. and its Western allies.

“Is terrorism an insurable event?” asked Neil A. Doherty, Ph.D., chair, Insurance and Risk Management, The Wharton School, University of Pennsylvania. “Well, possibly in the classic definition of what’s insurable, the answer is probably ‘no.’ Insurable events tend to be events which are relatively small in their impact, independent of each other (not correlated), and where the policyholder is not influencing the probability of loss, in other words, there is no moral hazard. It’s an event in which people have information, particularly insurance companies have information, so they can actually measure the expected loss.”

With terrorism, Doherty said, it is notoriously difficult to measure the risk. “Measuring the probability of a terrorism event is just not there. So in fact setting premiums is really very arbitrary.

“When we normally think of insurance markets and sharing the risks amongst parties, we normally think of the situation in which the party that has control over risk should actually bear that risk. Now on that basic principle, that would seem to define a role for the federal government in bearing risk in possibly a renewal on TRIA.”

However, Doherty offered other ways to manage risk should the protection of TRIA not be available later in the future. “There are other ways of managing terrorism risk by corporations, other than by buying insurance,” said Doherty. “They can include strategies such as changing the leverage of a firm, using its own capital to absorb this risk, as well as various financial instruments such as structured debt.”

Debra Ballen, executive vice president of the American Insurance Association, “TRIA simply cannot be allowed to expire.” However, Ballen added that TRIA is not the best long-term solution, and urged the industry to work together to develop a long-term solution that will provide proper terrorism coverage.

“The economic reality is that terrorism remains an uninsurable risk, but the political reality is that Congress expects the private sector to provide protection for policyholders against terrorism risk. So there is a bit of a clash here that needs to be resolved,” said Ballen.

Ballen went on to offer several suggestions for a long-term program, including that any long-term program should ensure an effective recovery and reconstruction effort immediately following a terrorist attack; and maintain a focus on protecting insurance industry solvency rather than the needs of individual company solvency.

“The program should encourage the development of new private market institutions for managing terrorism risk, while at the same time recognizing that some of the theoretical solutions that people like to think will work, simply will not work in the real world,” she added.

Ballen also stressed the need to maintain a viable private insurance market.

Other panelists discussed existing and potential terrorism threats to the U.S. “Quite clearly, Al Qaeda remains the principal focus of U.S. concern when it comes to trans-national imported terrorism,” said Peter Chalk, Ph.D., associate political scientist at the RAND Corporation. “The organization has not only defined its ideological and strategic agenda specifically opposed to the United States and its Western Allies, the group has also demonstrated a proven capacity to use land, sea and air modalities to strike out at a range of Western and American interests across the world.

“That said, the nature of Al Qaeda today differs remarkably from the organization that emerged out of Afghanistan in the late 1990s,” Clark added. With the loss of its safe haven in Afghanistan, many of the Taliban’s key leadership has been eliminated, or detained, and the remaining members have been dispersed throughout the Middle East and Central, South and Southeast Asia. This has led to a reconfiguration of Al Qaeda, resulting in a transition from a centrally controlled organization to a nebulous, segmented, and polycentric organization.

Al Qaeda’s current attack methods include tactically oriented strikes done by affiliated cells (individuals) and striking when the opportunity arises. Trends include hard targets (protected venues), soft targets (easy public access), an ongoing emphasis on economic attacks, suicide strikes, CBRN, and attacks against the food chain and agriculture.

“There continues to be a possibility of attacks by Al Qaeda on commercial interests within the United States that … underscores the ongoing need for there to be some sort of financial protection available to businessesæthe kind of protection that the Terrorism Risk Insurance Act was intended to encourage,” said Robert T. Reville, Ph.D., co-director of the Center for Risk Management at the RAND Corporation.

Reville said that the shift in risk from hard targets to soft targets “is a shift, to a great extent, towards the private sector. And since the private sector, to a great extent also relies on insurance, this reinforces the importance of a financial protection for commercial interests that may face terrorist attacks in the future.”

If TRIA were to expire in December 2005, Reville added, the price of terrorism insurance would increase, and therefore the take up rate of terrorism insurance would decline.

Bio-terrorism, or CBRN, is a faster-growing threat now than is weapons of mass-destruction, said Terry O’Sullivan, Ph.D., postdoctoral researcher with CREATE, University of Southern California.

Radioactive materials (i.e. dirty bombs) are also a prominent threat, especially to large shipping ports, including the Los Angeles and Long Beach ports, which see 36 percent of U.S. imports, according to Detlof von Winterfeldt, Ph.D., co-director of CREATE and professor of public policy and management at the USC.

Reville said that the threat of chemical, biological, radiological or nuclear attacks exposes the greatest weakness of the insurance market in the aftermath of 9/11 and the passage of TRIA. “While TRIA does offer reinsurance, insurers are not required to offer it, and therefore CBRN exclusions are common and the amount of CBRN coverage actually available in the economy is very low. As a result, a dirty bomb, for instance, in an urban area, would lead to widespread uninsured losses and the economic ramifications of such attacks would be severe.

However, Reville said, the possibility of extending TRIA to include coverage for CBRN would be very difficult and is highly unlikely.

Chalk said domestic terrorism also remains a threat as current terrorism insurance does not include coverage for a domestic terrorist group attack. A number of threats exist under the domestic terrorism category, and most of these threats appear to be the result of the phenomenon of anti-globalization.

“Anti-globalists at heart oppose concentrations of corporate and state power …,” Chalk said, adding that the goal of many of these groups is to exacerbate conflict and cause resentment.

Anarchism, far-right groups, and environmental extremism currently present the most prominent risk to the U.S, with anarchism being the number one security threat.

The risk of these threats exposes yet another hole in TRIA, Reville said. “Assaults perpetrated by a purely domestic entity in the United States are not covered by TRIA,” Reville reaffirmed. “Therefore, these sorts of attacks would have potentially more significant consequences than an attack that would occur from a foreign sponsor.”

Reville concluded that TRIA has significant gaps in its coverage, but its potential sunset, without additional congressional action, would slow recovery after future attacks and magnify the economic consequences of an attack.