Experts Report Commercial Property Terrorism Modeling Getting Better

April 18, 2005

Insurance companies are getting a better handle on how to estimate commercial property terrorism exposures and price the coverage thanks to advances in computer modeling.

Despite the strides made in modeling to estimate terrorism exposures, experts also noted that it is still an emerging field trying to address a problem that is inherently uncertain.

The recent Casualty Actuarial Society’s annual seminar on ratemaking covered the two main types of potential future terrorist attacks: conventional and chemical/biological/ radiological/nuclear (CBRN).

“In the area of catastrophe modeling, Hurricane Andrew was a real wake-up call to the insurance industry in terms of managing accumulations of property exposures, and similarly 9/11 was also a wake-up call in terms of managing accumulations of exposure across multiple lines of business,” David Lalonde, senior vice president, AIR Worldwide Corporation of Boston, a risk modeling company, told the actuaries.

Now insurers and reinsurers are taking a much broader view of catastrophe risk in addressing the financial exposure of possible future attacks, he added.

The ongoing improvement in the level of detailed data being collected in terrorism modeling shows the importance of examining exposures, the types of weapons terrorists might use, and their potential targets, according to Lalonde.

Terrorism modeling helps insurers in a number of ways. It gives them a more complete picture of an extreme event that could adversely affect their financial results, establishes underwriting guidelines to offer profitable coverage while controlling risk, and provides a better understanding of reinsurance needs.

Lalonde said the key questions answered by terrorism models are: What are the potential targets? What is the method of attack and what types of weapons could be used? Also, what are the effects of the weapons?

“In terrorism modeling, you’re looking at relationships between a certain size bomb and the amount of damage being done to a building and the surrounding area,” he said. “It’s led to an evolution of the models beyond physical damage, including injuries, loss of life, disability, and contamination which includes cleanup costs,” he noted.

Types of attacks
Lalonde said the types of attacks being modeled by AIR are conventional ones, such as bombs and airplane crashes, and CBRN.

The conventional attack damage estimates consider multiple effects on the target and surrounding buildings and CBRN events are modeled using the Department of Defense standard model, which includes the full spectrum of chemical/biological/nuclear weapons and can accurately predict the effects of the release of hazardous materials.

“We also have assembled a team of experts to identify terrorist groups, objectives, capabilities and resources, and the history of their attacks,” he said. “And based on expert opinions, we can estimate the potential frequency and severity of attacks by these groups.” The resulting threat index can then be spread across individual landmarks in a geographic area.

Results from catastrophe models can show the annual aggregate losses and the annual occurrence losses on an industry-wide and company specific basis.

The models also provide structural flexibility for geographic area, line of business and construction type for both foreign and domestic terrorist attacks using conventional or CBRN weapons, the AIR official said.

Insurance Services Office used the AIR terrorism exposure model to develop new filings on behalf of insurers. ISO Assistant Vice President George Burger took actuaries at the meeting through his organization’s process for commercial terrorism pricing.

“After the Terrorism Risk Insurance Act went into effect in 2002, we used AIR’s terrorism model to file loss costs for terrorism coverage,” Burger said. “Last year, we updated the original loss costs and made new filings based on the current threat assessment.”

For terrorism pricing, ISO has focused mainly on commercial property coverage, but has gone beyond that to include general liability, commercial auto and business owners, which combines property and liability, he said.

ISO pricing
ISO made adjustments to AIR loss costs including factors to account for insurance-to-value, the federal backstop factors (to reflect TRIA), and loss adjustment expenses, he said.

ISO’s 2004 review dealt with changes to both CBRN and conventional-type attack loss estimates. This had a larger impact in many cities and counties within large metropolitan areas, mainly due to the larger footprint of CBRN events.

Since the last quarter of 2004, ISO has filed projected loss costs and received approval in 45 jurisdictions to date. In most of the states the filings have been for increases because many counties and cities have moved from the lowest tier into the middle tier of terrorism risk.

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Insurance Journal West April 18, 2005
April 18, 2005
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