Industry Reports Progress on Terrorism Risk Modeling But Challenges Remain

Sophisticated catastrophe models are greatly aiding commercial insurance actuaries in establishing underwriting and pricing guidelines for terrorist attacks, according to industry experts at this week’s Casualty Actuarial Society’s (CAS) annual Seminar on Ratemaking in Atlanta.

A panel session on “Actuarial Analysis of Catastrophes and Terrorism for Commercial Insurance” outlined the challenges that actuaries face in translating the output from catastrophe models into financially meaningful numbers, such as rate indications and solvency analysis, as well as the impact of the federal Terrorism Risk Insurance Act (TRIA) on commercial insurance pricing.

David Lalonde, senior vice president at AIR Worldwide Corp., a risk modeling company, said his company had been modeling natural catastrophes for 15 years before the September 11, 2001 terrorist attacks on New York City and Washington, D.C.

“Soon after September 11th, clients began asking us for help in estimating their losses from the attack on the World Trade Center . There were no credible commercially available terrorism loss assessment models at the time, but we quickly generated a set of scenarios and overlaid them onto the detailed industry exposure database we used for our natural peril models,” Lalonde said.

He said insurance companies were able to utilize the results of this analysis to set up reserves. AIR subsequently released the first commercially available probabilistic terrorism model in 2002.

Because terrorism events are among the more extreme events in an insurer’s portfolio that contribute to the company’s risk profile, understanding that risk can help in setting up underwriting guidelines that will avoid over accumulations of exposure.

“Terrorism models also can help companies understand and price in the TRIA environment, pricing through ISO (Insurance Services Office) advisory loss cost filings, along with improving understanding of how much reinsurance is needed based on underlying exposures,” continued Lalonde.

AIR’s terrorism model consists of three major modules:
Hazard – the type of weapons used in the attack, the potential targets and the estimated frequency of attacks,

Engineering – the levels of property damage and injury, and

Loss estimates based on the type of coverage and policy conditions.

Lalonde said it’s not possible to model every possible terrorist attack, but his company has tried to get a flavor of the types of attacks that are possible – from conventional attacks, such as bombs and airplane crashes, to those from chemical, biological, radiological, and nuclear (CBRN) weapons. CBRN attacks are modeled using standards developed by the U.S. Department of Defense.

“Understanding the targets, their locations and the surrounding environment is important,” Lalonde noted. “The model captures scenarios ranging from potential targets in commercial areas that are small with little potential for damage, to downtown cores with high density that can greatly affect the distribution of damage.”

The most important thing for insurance company actuaries using terrorism models to understand is the location of potential terrorist targets relative to the company’s exposure, Lalonde emphasized during the session. “AIR has put together a team of experts, including former FBI and counter intelligence experts, to develop a list of potential targets and types of weapons that might be used, which are then distributed across an area and assigned probability factors.”

Lalonde noted that the World Trade Center attack “also highlighted that catastrophes can impact more than a single line of business.” The AIR terrorism model is used by insurers to assess and manage terrorism risk to their property, life and workers’ compensation lines of business, as well as to address inquiries by the various rating agencies.

Rimma Maasbach, actuarial consultant for Insurance Services Office (ISO), provided an overview of terrorism insurance pricing for the various lines of commercial insurance under the Terrorism Risk Insurance Act of 2002—the federal insurance backstop program approved by Congress after the September 11 terrorist attacks.

She said ISO ranked cities and counties by their expected loss potential using AIR’s model and rated them based on their degree of hazard: high, medium and low. New York City, Chicago, San Francisco and the District of Columbia were ranked in the highest tier for expected commercial property losses, with Los Angeles, Boston, Houston, Philadelphia and Seattle falling into the medium tier and the remainder of the country rated as low hazard.

The ISO consultant showed her fellow actuaries how the TRIA federal backstop works and its impact on insurer deductibles, coinsurance, the recoupment threshold and the program cap, or the maximum liability for insurers and the federal government—currently $100 billion.

She outlined the key features of the 2005 extension of the program, which still applies only to attacks by international terrorists, limits the lines of insurance covered by the act and changes some of the program’s parameters.

Thomas J. Duffy, U.S. chief actuary for Kingsway America , moderated the terrorism modeling session.

The Casualty Actuarial Society has more than 4,000 members.

Source: The Casualty Actuarial Society (CAS).