RMS: New TRIA Structure Shifts Risk Burden to Insurance Industry

January 4, 2006

Newark, Calif.-based Risk Management Solutions (RMS) recently assessed the risk of terrorism and quantified how the terms of the December 2005 renewal of the Terrorism Risk Insurance Act (TRIA) would shift the relative share of the risk from the government to the insurance industry.

RMS’ analysis, conducted for the Congressional Budget Office, shows that while TRIA provides solvency protection in extreme events, it is not an insurance industry subsidy. Based on the new TRIA terms, more than 90 percent of the RMS modeled average annual loss would be retained by the industry. If an attack occurred, there is also less than a 10 percent chance that it would cause the industry deductible to be reached, because only the most extreme, low-probability attacks will cause losses in excess of $30 billion, the analysis indicates. For example, the 2001 World Trade Center attacks resulted in approximately $32.5 billion of insured losses; were an event of this magnitude to occur today, it would produce only a minimal TRIA recovery for the insurance industry.

While the act was extended for two years, in 2007, insurers’ deductibles will increase from 17.5 percent of direct earned premium (DEP) to 20 percent of DEP, and the government quota share on losses above the retention shrinks from 90 percent to 85 percent. That will lead to another significant increase in the amount of terrorism risk held by the industry, highlighting the need for insurers to focus on terrorism risk management, the analysis shows.

“Several years ago, companies focused on exposure accumulation and scenario modeling, but now they are using probabilistic modeling to help inform decisions on underwriting guidelines, risk selection, reinsurance transactions, and the possible securitization of terrorism risk,” said Peter Ulrich, senior vice president of enterprise risk management.

The TRIA extension provides a two-year window to allow the industry to determine how best to prepare for or disengage from providing terrorism risk coverage. Determining the value of continued provision of terrorism coverage will therefore demand a comprehensive assessment of risk, available capital, pricing, and their ability to withstand extreme losses, according to RMS.

“Near-term terrorism risk in the U.S. has decreased since the initial TRIA bill, mainly due to homeland counter-terrorism measures, but the Jihadist threat continues to rise worldwide,” stated Dr. Andrew Coburn, director of terrorism research at RMS. “Anti-American terrorist attacks have increased worldwide, and the U.S. homeland remains a primary target for Jihadist terror groups. Our assessment suggests that the threat of macro-attacks within the U.S. will remain for many years. More troubling is that the capability of threat groups to carry out larger scale attacks is increasing over time.”

At the end of 2007, individual insurance and reinsurance companies could face the challenge of bearing the risk of terrorism losses with no government backstop. Managing that risk, therefore, will require that companies ensure that they have sound underwriting practices and accumulation controls, good analytical tools, and discipline throughout the organization.

RMS has participated throughout the TRIA debate, including through its co-founding of the RAND Center for Terrorism Risk Management Policy and its August 2005 publication of A Risk-Based Rationale for the Extension of the Terrorism Risk Insurance Act,” available from www.rms.com.

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