Terror Risk Transfer: The Evolution of the Attacks and Why the Market Needs to Grow

Violence broke out almost simultaneously in two European countries only a couple of weeks ago. Shortly after a truck drove through the Bastille Day festivities in Nice, causing 87 fatalities and 203 injuries, according to early reports by Verisk Maplecroft, an attempted coup d’état in Turkey left more than 250 people dead.

As a whole, 2016 has been far from quiet. Less than a week after the events of Nice and Turkey, a man wielding an axe, injured 18 on a train in Würzburg, Germany. This was the first attack with explicit terrorist motive in Germany in 2016, and it was quickly followed by three more, with events occurring in Ansbach and Stuttgart.

For the 12-month period ending July 2016, approximately 40 terror events in Europe (excluding Turkey) have caused more than 25 fatalities and more than 850 casualties. While frequency is down 70 percent, the events have become much more lethal. For the prior 12-month period, fatalities topped 30, with nearly 90 casualties. There’s clearly a trend emerging across Europe.

Meanwhile, the global insurance and reinsurance industry expects few losses from terror events, based on the profile of those that have occurred. After all, it hasn’t sustained many of those that have transpired. With terror activity trending toward smaller events designed to maximise loss of life and instill fear in the public – as opposed to property damage – recent attacks have centered on small arms fire and smaller explosions. This evolution of terrorism and the methods used to carry out terrorist attacks indicate that, based upon the current terrorism insurance products available, significant insured losses appear to be unlikely.

Doubtless, losses are being sustained; they just aren’t making it into the global insurance system. And if this isn’t a significant problem for corporate risk managers yet, it could become one. At the same time, it could provide an opportunity for the global insurance industry to deploy more capital (in a market where its abundance has been problematic) and the market to grow its commitment to provide financial protection to the public to help it recover post-event.

Why Carry the Whole Loss Yourself?

There are a number of reasons why risk managers should be more focused on seeking terrorism cover to deal with the recent uptick in terrorist attacks.

First, the loss of revenue caused by an event can be significant – and may not be covered by existing insurance policies. Seemingly little terror loss makes it past the corporate’s own balance sheet. Especially for soft targets (like hotels), an attack can be easy to complete and cause damage far longer than the duration of the event itself.

Brand or reputational damaged sustained by original insureds could be offset by sufficient and appropriately structured insurance protection. For some businesses, simply the loss of life on their premises can provide long-term brand damage, particularly if the losses are deemed to have been ‘preventable’ by public opinion. For certain types of cover, concentrations of risk can exacerbate the issue. Group life is a great example. Generally, terror attacks on soft targets pose little risk to life insurers. They may sustain some losses, but in a public space, many life insurers would be affected. And there’d be plenty of fatalities involving uninsureds. For a company that offers group life, though, a single insurer could sustain a significant loss from a workplace terror event. That would come in addition to the brand/reputational loss sustained. Ultimately, brand loss translates to revenue and earnings loss, which cascades to shareholder value.

Given the rise in terrorist event frequency, risk managers should seek out appropriate insurance to cover more of the losses they stand to experience. The influx of capital post-event would help it return to normal operation sooner, maintain customer confidence, and protect shareholder wealth. Even an event occurring near a business could have an impact, so broader thinking is crucial for corporates looking for ways to hedge the terror threat.

Reality dictates that the situation must change, but this is not without challenges. The first is for primary insurers (or capacity providers going directly to the original insured) to develop solutions to the evolving terror threat. Some activity has occurred in this space this year, particularly with ‘active assailant’ cover to address attacks like the one that occurred in San Bernardino in December 2015.

There are a few types of cover, ultimately, that need to come to market and be made attractive to corporate risk managers: emergency post-event cover, traditional insurance (indemnity) for terror, and protection for the large losses caused by massive events (such as the terror attack of September 11, 2001). The first of the three likely provides the most opportunity for innovation. The second cover: traditional insurance (indemnity) can be adapted and modified to ensure it is more reflective of the current risks and the last form of cover: terrorism cover caused by massive events, are usually insured with the assistance of terrorism risk insurance pools.

How to Deliver Low-Friction Emergency Financing

What happens when a terror event occurs? In our industry, it’s easy to focus on the mechanics of protection, terms and conditions, and estimating the size of the loss. If the global insurance and reinsurance industry really wants to make a difference, it needs to think about what happens at the most fundamental of levels. People are scared. Terrified (the word fits for a reason). Angry. Grieving. Confused. Unsure of what’s going to happen next. And the knock-on effect makes things worst. In addition to feeling all of the above, affected individuals (and those living within close proximity to an attack) start to wonder how much food is left at the grocery store. Or whether a follow-on attack will occur and when. Patterns of going out to restaurants, bars and other public places is likely to be impacted as a correlation of the fear and uncertainty. If there was damage to public infrastructure, many will wonder how they will get to work. If they can’t, they’ll worry about how they’ll feed their families.

The fear and uncertainty is coupled with economic impact at the household level and for the community as a whole – both businesses and government. Even if there isn’t much physical damage, the economy and community are disrupted. Loss of customer, business interruption, and reputational loss are quite likely.

And underlying all of it is the fact that people have basic needs that they’re worried about being able to address.

Emergency financing clearly could play an important role in post-event recovery, in light of the early factors that are involved in a terror strike. Communities need to provide aid and support. Businesses need access to inventory. People need to get to work.

Even where there is traditional protection in play, it can take time – and that’s up the reinsurance and retrocessional chain, as well. Municipalities relying on aid can wait for months – or longer – to get help. For many businesses and communities, the ability to have capital and emergency deployed to them quickly can be the difference between the business surviving, recovering and eventually thriving again and a business facing bankruptcy.

From the perspective of insurers, claims assessments need to be made and claims adjustors deployed. However, from the perspective of the business, particularly where there is a low profit margin and a reliance on cash flows, the longer the process takes to assess the damage and make payments, the greater the terrorist impact upon the business. The insurance industry, particularly in light of the access to capital, has the ability to design financial insurance products which facilitate emergency financing and can provide funds very soon after an event.

Corporate and Community Resilience Through Parametric Triggers

One of these insurance products may involve parametric insurance products for losses arising from terrorist events to compensate for loss of lives, injuries, reputational losses and other losses currently not covered by traditional terrorism risk insurance. A parametric cover may be quite simple, or it could involve a higher degree of structuring based on the needs of the protection buyer. While this approach is still in its infancy, there’s enough interest – as there is in the parametric space in general – to suggest that it could be a useful and important risk-transfer tool in the future.

Among the greatest challenges in the index-triggered terror risk-transfer space is the need for a single source as a reporting agent. Terror ILWs, for example, can have a dozen different data sources (or more), based on the geographic scope of the cover. Verisk Insurance Solutions has worked with the industry to ascertain ways that Verisk Maplecroft terror event data could be used in parametric triggers, to encouraging early results. Verisk Maplecroft records details on approximately 30 attributes for terror events worldwide, including location down to 1 km², perpetrator group, incident/weapon type, duration, fatalities, casualties, and hostages. Through this information and the appropriate use of hours clauses, an effective trigger could be developed to provide for the rapid determination of whether a trigger point has been reached in order to deliver much-needed post-event emergency financing.

Let’s consider recent events, based on the evolution of terror activity. ISIS has demonstrated a focus on generating the greatest loss of human life from their activity, which makes a trigger based on monetary or insured loss less relevant. With this in mind, a parametric trigger tied to injuries or fatalities (or both) could provide sufficient, independent, and fast results for protection buyers. And this could be enhanced with location information, event duration, and attack type (if, for example, one would want to exclude CBRN).

Notwithstanding a rapid transformation of the terrorist threat, coupled with an evolution in how attacks are carried out, the terrorism insurance market remains relatively stagnant. In other areas of the commercial world, there are clear movements towards innovation and thought leadership in terror modeling, tracking, and response. The insurance industry, however, isn’t developing as quickly – even despite the prevalence of activity. Yet the industry has the capacity for change – and to deliver meaningful positive impact to people and communities in their time of need. Developing and distributing a parametric solution for terror events with low physical damage could be an important first step toward addressing the new and evolving terror threat.

This article was contributed by Rachel Anne Carter and Tom Johansmeyer.

Rachel Anne Carter is currently the Managing Director of Carter Insurance Innovations Ltd and the co-founder of the Journal of Terrorism and Cyber Insurance. Rachel is a dedicated insurance professional, published author, well established catastrophe researcher (within both natural catastrophe and man-made catastrophe: terrorism, cyber and other emerging risks) and university law lecturer with experience running an insurance consulting firm. Her experience was gained from her work at the OECD (primarily in developing the E-platform on Terrorism Risk Insurance and working on natural disaster insurance projects with APEC), Pool Re (researching for the CEO), Lloyd’s, Tokio Marine Kiln and several Australian Universities.

Tom Johansmeyer is Assistant Vice President – PCS Strategy and Development at ISO Claims Analytics, a division of Verisk Insurance Solutions. He leads all client- and market-facing activities at PCS, including new market entry, new solution development, and reinsurance/ILS activity. Currently, Tom is spearheading initiatives in global terror, global energy and marine, and regional property-catastrophe loss aggregation. Previously, Tom held insurance industry roles at Guy Carpenter (where he launched the first corporate blog in the reinsurance sector) and Deloitte. He’s a veteran of the US Army, where he proudly pushed paper in a personnel position in the late 1990s.