Evolution of Terror

2014 is a transitional year for terrorism (re)insurance given the evolving landscape of global terrorism threats and, in the United States, lawmakers’ contemplation of the future of the Terrorism Risk Insurance and Program Reauthorization Act (TRIPRA).

The public-private partnership is scheduled to sunset on December 31, 2014, and consumers, (re)insurers, risk managers, creditors and the U.S. Department of the Treasury alike all must face the implications associated with a materially amended or non-renewed legislation.

This year has brought to light many new developments on the global terrorism stage. Conflicts across the globe have eased access to munitions, created hotbeds of activity and muddled allegiances.

Concurrently, technical advancements have given terrorist organizations new mediums to promote their ideology, recruit new members and provide a megaphone for their violent dogma. Sophisticated cyber-attacks have also opened up a new avenue for warfare and eased the degree to which black-hats may circumvent Western governments’ interdiction efforts.

Understanding insurgent capabilities – both foreign and domestic – is a core driver of risk management, both when discussing (re)insurance and the protection of sovereign interests.

In June, Guy Carpenter released its annual global terrorism report, which updates clients and reinsurance contemporaries on continuously shifting geopolitical landscapes, terrorism threats and capabilities, risk modelling solutions and the breadth of private market (re)insurance capacity.

STATE OF AFFAIRS

Since the attacks of September 11, 2001, the threat from terrorism has undergone significant change. Heightened and more effective counter-terrorism activities in the following years have prevented repeat attacks on the scale of those carried out in New York and Washington D.C.

In the last 18 months, there have been several events on an international scale: the crisis erupting in Mali following a jihadist uprising; the death of 29 foreign nationals at the Sonatrach oil facility in Algeria; explosions at the Boston Marathon causing in excess of 260 casualties; the murder of 67 civilians at the Westgate shopping center in Nairobi; and the murder of a British soldier outside of his barracks in London. This narrative clearly serves to underscore the jihadists’ global reach.

Core players on the world stage include Core Al-Qaeda, Al-Aqaeda in the Arabian Peninsula (AQAP); Al-Shabaab; Syrian Jihadists such as Jabhat al-Nusra and the Islamic State in Iraq and the Levant (ISIL/ISIS); and non-Islamic terrorist groups such as Fuerzas Armadas Revolucionarias de Colombia (FARC).

EVOLVING THREATS AND POTENTIAL FUTURE RISKS

The wars in Syria and Iraq are extremely complex, drawing on sectarian tensions that go back centuries. In Syria, this environment has seen extremist groups emerge as dominant forces among rebels, raising fears that the nation could become a hotbed for terrorist activity, akin to Afghanistan and Iraq.

The British government has already reported that more than 500 U.K. nationals have joined the fighting.

Similarly, the recent rise of the Islamic State in Iraq (ISIS) has given way to significant advancements in the destabilization of the U.S.-installed Iraqi regime, particularly in northern territories. This ongoing civil conflict shows not only the military prowess of “Al-Qaeda in Iraq,” but for the first time threatens to cripple a sovereign identity and demarcate the nation along sectarian lines.

TERRORISM IN THE REINSURANCE MARKET

Despite the recent spike in terrorist-related activity, expanded industry capital and the absence of a major terrorism loss for reinsurers have resulted in a softening terrorism reinsurance market in areas with lower perceived risk.

This is in tandem with the wider reinsurance market’s environment of evolving capacity due to low catastrophe loss experiences, strong balance sheets and an influx of capital from alternative sources. Much of this alternative capital is being deployed in the U.S. property catastrophe market, prompting reinsurers to move some of their capacity away from pure natural perils exposures and into other product lines.

It should be noted, however, that this convergence capital has yet to become a major contributor to the U.S. terrorism reinsurance market.

Additionally, while global reinsurance rates have softened over the last 18 months, capacity constraints surrounding Tier 1 cities (New York, Chicago, Los Angeles, San Francisco and Washington, D.C.) and high-profile targets have led to a more demand-driven environment for terrorism pricing.

Terrorism, unlike many classes of business, clashes across product lines and requires a large capital allocation from the ultimate risk bearer.

Specific to the United States, talk around non-renewal of TRIPRA has sent ripples through the insurance and reinsurance marketplaces, respectively. Primary carriers have enacted a series of conditional Terrorism Risk Insurance Act (TRIA) exclusion endorsements, short-term policies and, to a lesser extent, have shifted geographic profiles or non-renewed certain insureds.

The reinsurance market, however, has seen buyers become more aware of their terror exposures and attempt to take advantage of softening coverage conditions – albeit with varied results.

While original lawmaker sentiment was varied, and certainly a non-renewal of TRIPRA would leave the U. S. market illiquid, congressional support now leans in favour of program reauthorization. There is now a mixed array of potential outcomes at January 1, 2015.

At June 30, 2014, each legislative house has presented a bill to send to vote:

• Senate: Terrorism Risk Insurance Program Reauthorization Act of 2014; and

• House of Representatives: TRIA Reform Act of 2014.

To varying degrees, both bills seek to move U.S. Treasury outlays further away from loss.

In whatever shape the final act takes, insurance carriers writing primary property coverages and, to a greater extent, workers’ compensation cover, will need to reassess their reinsurance needs.

Workers’ compensation is regulated by state laws and precludes carriers from putting a policy limit on the coverage, or excluding any perils (including conventional or nuclear, biological, chemical and radiological, or NBCR, terrorism) on workplace injuries. As such, there is no theoretical maximum exposure for workers’ compensation risks.

Facing ratings agency pressure, many companies have already taken action to improve data sets and refine aggregations with the overriding objective of reducing their probable maximum loss from large individual accumulations.

Guy Carpenter estimates the theoretical maximum limit available for multi-line, standalone terrorism reinsurance capacity is US$2.5 billion per program when excluding NBCR and US$1 billion per program inclusive of NBCR.

It is cautioned, however, that the aforementioned figures contemplate ample pricing and do not take into account aggregate caps on geographic locations.

In central business districts, and for the accumulations surrounding certain high-value targets, these geographic caps can exponentially affect both the affordability and availability of cover as reinsurers look to place a floor on their total downside exposure.

INTERNATIONAL IMPLICATIONS OF TRIPRA

Private market reinsurance capital has certainly grown over the last 24 months, but modelled loss estimates for workers’ compensation and property terror events still pose a significant threat to industry solvency.

The legislative outcome on TRIPRA, therefore, will have international implications. If TRIPRA were to expire or materially reduce federal involvement, a ripple effect is expected to bleed over into the Canadian sector. Global or international companies that write in both markets will likely have to make tough choices about capital allocation.

If the holding group must shift more capital into the U.S. market to offset increasing exposures, then it is likely there would be a restriction of Canadian capacity, assuming no further surplus growth.

Similarly, Canadian companies with U.S. workers’ compensation exposure may face a hardening rate environment as statutorily unlimited policies bear a greater net exposure to the carrier.

Conversely, if groups make a decision to pull out of the U.S., then it is possible that certain pockets of the Canadian arena would experience softening with an influx of new entrants seeking a flight to quality.

The issue is compounded by the absence of a national pool or back-stop program in Canada, leaving private (re)insurers with a fair degree of market uncertainty.

There are, however, recent legislative developments that seek to cement the status quo: specifically, British Columbia and Alberta enacted amendments to their respective Insurance Acts on July 1, 2012. The amendments address losses incurred by fire and explosion resulting from a terrorist attack, and allow for terrorism exclusions on commercial policies.

Simultaneously, the amendments provide a coverage write-back for commercial properties with residential occupancies. Strike, riot and civil commotion losses, however, remain excluded under such amendments.

Terrorism remains a threat on a global scale and the insurance industry plays an important role in protecting the fortunes of those who fall in harm’s way.

The entire (re)insurance community should be working to raise the awareness and importance of available and affordable terrorism (re)insurance capacity to support economic growth in North America. Within the terrorism space this means finding cost-effective risk transfer solutions, understanding legislative impacts and managing the threat landscape.