Terrorism: Defusing the terrorism bomb

Last month’s terrorist attacks in Paris serve as a stark reminder that the threat of attack remains very real. But while the massacre at Charlie Hebdo was something of a wake-up call to society in general, broader industry moves are having a much greater influence on the terrorism insurance market.

While the events in France were tragic, James Borrie, executive director in Willis’s Terrorism Practice, says an attack was not unexpected. “Europe has been on a severe threat level for some time now, meaning a terrorist attack was highly likely,” he explains. “Insurers have been pricing for this already so we won’t see premiums increase as a result of the Paris attacks.”

In addition, although devastating in terms of the number of lives lost, the value of the losses that will be absorbed by the insurance market are only minimal. Cover extends to property damage and business interruption, and as losses in both of these areas were fairly limited, claims will be relatively low. As a result it’s highly unlikely that policyholders will be hit with a price hike following the Paris attack.

“There’s plenty of capacity around the world,” says Borrie. “Even though risk appears to be increasing, premiums are falling.”

Importance of cover
However, while it may have had minimal effect on the terrorism insurance market, it has served to remind businesses of the importance of cover. “Terrorist attacks such as Paris and Sydney [coffee shop] bring home the fact that the threat is very real,” says Andrew Page, political violence underwriter at Beazley. “We always see an increase in client enquiries about cover following an attack.”

While recent attacks have sparked interest in insurance among businesses with no cover, the way terrorist attacks have evolved also raises questions about the cover that is in place. “Twenty-five years ago, terrorist attacks were much more about economic damage, for example, the IRA’s Baltic Exchange and Bishopsgate bombings,” says Simon Low, divisional underwriter, political risk and crisis management at Canopius.

“Today we’re seeing an increase in lone wolf attacks and terrorist cells operating in small groups using weapons and explosives to injure and kill people.”

This shift has affected the losses that businesses suffer in an attack. A good example of this is the Boston Marathon bombings in April 2013 which killed three and injured more than 250 spectators. Although there was little property damage, the site was closed for several days to enable the police to carry out investigations. During this time, local businesses were forced to close, resulting in lost revenue.

Page says this is reflected in the enquiries his firm receives. “Businesses want to know more about business interruption cover and other related extensions, such as denial of access and ingress or egress,” he explains.

These changes in the nature of terrorist attacks have put insurance under the spotlight too. And, with some agreements up for renewal, it’s been a perfect opportunity for an overhaul.

This has been the case with the UK’s terrorism insurance scheme, Pool Re, which is currently exploring a number of potential changes. Catherine Dixon, head of property and casualty at Allianz Commercial, welcomes this move. “The rest of the primary insurance market has moved on in the way it approaches risk and pricing but, perhaps because it has no competition, Pool Re has hardly evolved since it was introduced,” she says. “This modernisation will give it a chance to catch up.”

The catalyst for the overhaul was the government’s demand for an increase in its fee. When the fund was set up in 1993, the government agreed to take 10% of premiums in return for an unlimited guarantee. However, under a new seven-year deal, this was increased to 50% from 1 January 2015.

On top of this increased fee, Pool Re now guarantees a dividend payout of half of any surplus, with this split evenly between the government and its members.

Although the increased fee resulted in plenty of press speculation that this would see the cost of cover rise, Julian Enoizi, chief executive of Pool Re, is keen to dispel this rumour. “It’s really just a change in where some of the premiums go,” he says. “Instead of building up in a fund, it goes to the government. If there is a loss that exhausts the fund, the government would step in. This doesn’t affect premiums in any way.”

Substantial remaining pot
Similarly, Borrie doesn’t think the increased fee will be a problem. “Why shouldn’t the government take more?” he asks. “The pot is substantial and premiums are still being paid in. The government remains a backstop if large losses occur and, if the pot is eroded, it may reconsider the fee it takes."

Indeed, while Pool Re has paid out more than £600m in a dozen or so claims since it was set up, the fund currently stands at around £5.5bn. Although this could potentially be wiped out by one event, availability of cover will not be affected by the speed at which the fund grows in the future.

While the fee increase may have grabbed the headlines, the compromises Pool Re was able to negotiate are potentially much more significant for the UK’s terrorism insurance sector.

The finer details of these are still being thrashed out, with this exercise due to be completed later this year. Enoizi explains: “We’re looking to use modern modelling techniques to make sure premiums are more risk reflective. The fund works well at the moment, but there is room for modernisation.”

Several different strands make up this modernisation. As well as overhauling the four cover zones to ensure they more fairly reflect risk, Pool Re will be able to adjust rates to take into account a business’s risk management strategies or a large deductible. Dependent on the work currently being undertaken, it is expected that larger organisations will see any risk mitigation measures finally being recognised through reduced premiums.

Smaller businesses are also set to benefit, with Pool Re looking to create a product especially for SME clients. These businesses have traditionally shied away from terrorism cover but, by creating a simpler, lower-cost product more suited to their needs, it is hoped that take-up will increase.

This is a move that Graham Prior, technical underwriting director at Zurich Insurance, welcomes. “In many ways SMEs are less able to absorb the consequences of a terrorist attack as they do not have the spread of risk and locations that larger firms may have,” he explains.

This type of product for SMEs could also drive broader benefits. “At the moment take-up of cover is concentrated among larger companies in central London,” says Enoizi. “By appealing to smaller businesses and those outside of the capital we could get more diversification across the pool.”

HM Treasury has also given Pool Re the go-ahead to purchase retrocessional capacity from the private market. Enoizi believes this could help encourage more appetite for this risk. “It allows the reinsurers to dip their toes back in this market. Over time they might look to increase their activity in the commercial market too,” he says.

Although the details are yet to be finalised, the changes have been welcomed by the industry. “The hard-fought negotiations have resulted in the essential features remaining intact, alongside the opportunity to modernise some elements,” says Prior. “We’re fully supportive of the changes and the outcome they’ll achieve. The industry couldn’t offer such wide-ranging and extensive cover without Pool Re and government backing.”

His view is echoed by Dixon. She says Pool Re takes the terrorism cover headache away from primary insurers. “When the debate turned to whether it was viable for Pool Re to continue, we were forced to look at other options that could replace it – but it wasn’t easy,” she adds. “We do take it for granted but it is an exceptional facility and the proposed changes will really benefit the end customer.”

However, while the modernisation programme has received the thumbs up, not everyone is expecting it to drive more sales. Borrie says: “If a business isn’t buying insurance now, it’s unlikely to buy as a result of the proposed changes to Pool Re. There are already simple products available for small businesses. For example, at Willis, we can offer SMEs cover by blocking all the business together.”

A bit of a tussle may have taken place to agree the new terms for Pool Re, but this was relatively tame in comparison to the manner in which the US’s Terrorism Risk Insurance Act was renewed.

Like Pool Re, TRIA provides a guaranteed backstop for terrorism insurance claims and, while it was first introduced as a temporary measure back in 2002, it was extended in 2005 and 2007. But, when it expired at the end of 2014, insurers and their policyholders were left unsure of their cover if an attack occurred, with this uncertainty continuing until 12 January 2015 when an extension was granted.

Positive reaction
The news of the extension was largely positive according to Tom Dawson, partner in the insurance practice team at US law firm Drinker Biddle. “It was an unusual situation and there will be some additional work for insurers – who will need to go back and issue notices under TRIA – but the extension does remove uncertainty,” he says. “It should mean a minimum of disruption to some of the major projects that require appropriate coverage.”

But while it’s good news that it’s been extended, Page says all the drama surrounding the renewal of TRIA will force businesses to reconsider the cover they have in place. “When it looked like it might be withdrawn, the standalone market demonstrated there was a viable alternative,” he explains. “Even though TRIA has been extended, the limitations on the cover do mean that businesses will now be questioning whether it’s right for them.”

Certainly the cover available under TRIA does have its shortfalls. For example, one of the key requirements for TRIA to be triggered is that the event is certified. This means it must be regarded as an act of terrorism and losses must exceed $100m. This trigger is increasing by $20m a year and already some significant events such as the Boston Marathon bombings haven’t received certification.

As a result of this, Tim Davies, underwriter, political risk and crisis management at Canopius, expects to see more businesses looking at standalone cover. “TRIA was introduced to give more certainty when there were concerns the market didn’t have sufficient capacity,” he explains. “Today though, capacity has increased and the price has fallen. Standalone cover does offer a viable alternative for those who want the contract certainty that’s not always there on TRIA.”

The market is also looking at emerging risks in the terrorism arena, with cyber being regarded as the next battleground. Already a number of significant attacks have taken place. For example, in August 2012, the Cutting Sword of Justice claimed responsibility for an attack on Saudi Aramco. This wiped more than 30,000 of the firm’s computers, leaving the screens with an image of a burning US flag.

Understandably, as the risk – and the potential for losses – grows, there are calls to add these types of attacks to terrorism cover. Prior explains: “At the moment relatively few customers buy cyber cover, so it’s not clear what demand there would be to cover terrorist-related cyber attacks, but I’m sure it’s something Pool Re, the industry and the government will continue to monitor closely.”

There are also concerns about how easy it would be to extend terrorism insurance to include cyber attacks. The nature of the losses – which tend to be business interruption and reputational damage – are a step away from the property damage trigger on terrorism insurance. On top of this, Davies adds: “How do you determine whether an attack was perpetrated by a terrorist or a disaffected youth who wanted to see what they could do? If a company suffers a loss they don’t care who was behind it, they are just seeking to ensure insurance protection is in place.”

But as awareness of the need for terrorism insurance grows and the nature of attacks shifts, the industry will need to keep a check on whether its cover is in line with both risk and customer requirement.

This article was published in the 12 February edition of Post magazine.