Terrorism insurance portfolios: tales of the unexpected

Terrorism risk has evolved enormously in the past five years to encompass threats many in the industry would not have been able to predict. However, despite the huge changes in this class industry experts are clear that it remains profitable—even as some re/insurers reduce their rates.

This is the thinking of a group of experts who spoke on an Intelligent Insurer Re/insurance Lounge panel titled “An ever-changing risk: how insurers manage terrorism risk in their portfolios” in December 2020.

The panel included Steve Coates, chief underwriting officer at Pool Re; Emma Karhan, head of terrorism specialty and reinsurer relationships at Aon Reinsurance Solutions; Hui Zhi Pek, war and terrorism underwriter at Markel International Singapore; and Tim Davies, head of crisis management at Canopius, with Intelligent Insurer’s deputy editor Claire Churchard moderating the discussion.

“One of the unique features of terrorism is that it changes in ways that other catastrophe perils, like storms and floods, perhaps don’t,” said Coates. The past 20 years have been a good example of that.

“The risk has moved from guns to vehicle bombs to planes, through 9/11, and now, in the G20 countries, terrorists’ tactics have reverted to ‘do what you can’.”

Motor terrorism, where a vehicle is used as a weapon, is a key example of that, Coates said.

“If we had been sitting here five years ago discussing how the class has changed, probably none of us would have said that the next insurance market to fail in the UK would be motor.”

He was referring to the pressure on motor insurance that arose after an increase in vehicles being used in attacks, something motor insurance was not designed to protect against.

In response, the motor insurance industry agreed that motor terrorism should be underpinned by the UK Motor Insurance Bureau, funded by an industry levy. It applies to incidents that occurred on or after January 1, 2019.

Terrorism as a class has continued to evolve at speed, with Coates saying that over the past six to nine months, security professionals he speaks to have been voicing concerns about the future of chemical, biological, radiological and nuclear (CBRN) and cyber terrorism.

COVID-19, he said, is “a great example of a naturally occurring biological pathogen”, adding that the industry would be naïve to think that every terrorist group is not looking at something that has brought the world to a standstill and thinking “how can we do that?”.

“Terrorism has changed and will continue to change enormously, so we should be cognisant of that as we’re developing products and propositions,” Coates said.

Confusing cover

Karhan agreed that terrorism exhibits an element of the unknown not seen in other classes. She said that until COVID-19 and the Salisbury poisonings of 2018 using the military-grade nerve agent Novichok, “we wouldn’t have talked about non-damage business interruption (BI) and how that has impacted the world”.

“There’s a real risk around terrorism that we haven’t dealt with before,” Karhan said.

The complexity of the class and the ever-changing nature of the risk make it “very confusing” for the policyholder to try to understand all the things that they’re supposed to be thinking about buying cover for, added Coates.

“Most brokers struggle to keep up, let alone the policyholders. Unfortunately in today’s marketplace a lot of policyholders are buying cover direct through online propositions, and they don’t get the advice that they might otherwise have 10 or 20 years ago,” he said.
Davies said part of the confusion comes from the array of products that are out there.

“A good example of that would be active assailant cover. I talk to our brokers in the US who get risk managers saying: ‘I want to buy active assailant cover’, and they say ‘what do you want to buy?’.

“There’s immediately a great pause because no-one quite knows,” he explained.

“Are these risk managers trying to buy it from the liability side or from the BI extra expense side?” he asked. There is a lot of different products out there, but there isn’t a standard product, he added.

“It’s rather like the standard terrorism wordings that tend to be out there: every single market has their own different version of it and they are totally different in some cases.

“It’s an example of where you’ve got something where there is an interest but there is a slight disconnect between the client and the client’s needs.”

Profitable class?

As the broader insurance market hardened over the course of 2020, some might have expected rates for terrorism insurance to follow suit. This is not the case, according to the panel.

“As underwriters we always hope that rates are going to go up because consistently over the last few years, or for the last decade probably, we’ve seen year-on-year decreases in premium,” said Davies.

“A lot of that is to do with terrorism being a very profitable class—the expectations are that rates would go down and there’s been a lot of capacity in the market.”

There has been some hardening in terrorism rates, but Davies said it was not in line with the rest of the market.

“It’s not so much the same as direct & facultative global property, not so much as some of the other stuff, but we are seeing green shoots and an upward movement in it.”

He added that rates for “the very bog standard terrorism risks” in the developed world are relatively flat, but in 2020 there was a lot of activity in the Latin American region, particularly in Chile. “In places like that there have been huge rate increases.”

Davies is seeing “almost bifurcated” books, with some bits going up and some remaining flat.

One thing he is not seeing is expectations of a rate decrease. This is partly because of uncertainty around what insurers’ reinsurance is going to be, and the acknowledgement that this cost is not likely to reduce. Another market element influencing rates is that industry professionals are looking at the cost of capital, he said.

Coates agreed that there’s not much correlation between what’s going on in the property world and the wider world of casualty.

“The drivers of underwriting rationale are slightly different and terrorism, as Tim said, has been a very profitable class for some considerable time. We reduced our rates slightly at the start of 2020 and with our retrocessional purchase, the rating has edged down year on year from a fairly low base.

“I don’t see any current signs of significant hardening even though the retrocessional reinsurers are trying to talk the market up as you would expect.”

Profitability

Pek said that rate patterns for terrorism in Asia are as diverse as the different countries in the region.

“In locations where we have seen a bit more unrest in the past 12 months—Hong Kong and Thailand are good examples—there are some increases but it’s quite uneven. It really depends on the actual risk itself.”

She said that for other locations that are slightly lower risk, such as Singapore and China, there are fewer requests for rate reductions.

“That’s a good sign because people have been asking for reductions for the past 10 years. It’s a nice change that people have stopped expecting the rates to decrease.”

How does this differing rate environment affect the profitability of the class?

Coates said that Pool Re’s experience of buying quite a big tranche of retro for this is that reinsurers continue to view terrorism as a diversifying class.

“It’s not US cat or US wind, so for those who have the appetite it continues to be something that they want to write—albeit there are different risk appetites.”

Some people are more uncertain about writing terrorism because it’s very difficult to understand the model, he said.

“But for those who do have the appetite it continues to be an attractive class. And as long as the loss experience continues to be generally very favourable it’s difficult to see that changing, absent an event or some other capital event.”

Conventional vs non-conventional

A key distinction to make is the difference between profitability and pricing, whether you have cover for conventional physical weapons such as guns versus cover for non-conventional attacks such as cyber or CBRN, said Karhan.

“CBRN continues to be a constrained part of the class that can underpin the pricing and restrict your available capacity, because of its lack of transparency around the exposure itself and the higher capital costs that go with it,” she explained.

She added that as a broker she, and others, are constantly arguing that CBRN is a profitable class. But, she adds, there’s also the cost of capital to take into account. Reinsurers try to use the cost of capital to argue that CBRN is not as profitable as it might seem.

Davies said that in 2020 there were more losses coming through than he had seen previously in the terrorism market.

“Because these losses are not true cat losses, they tend to hit individual syndicates or individual insurers on a separate basis. For example, not everyone was hit with all the Chilean risks or the Hong Kong losses that came in,” he said.

But, he admits, what the market hasn’t had is a major cat loss, which also probably affected it in some way.

“With senior management looking at terrorism risk and placing it, it certainly isn’t the free money that it was sometimes pushed out to be. And with the loss pictures coming through people are seeing that there is a potential.

“People need to remember that you’re sitting on very big aggregates out there so the potential downside is pretty large,” he added.

Pek sees a general consensus that the class has been profitable for the past 20 years.

“But the turnover rate of the market right now says a lot about how the market has reacted, and clearly the rate reductions have not been sustainable. This is what’s causing so much change in the market at the moment,” she said.

“Before more capacity jumps into the market, it is important to make sure that you didn't decide to join this share of the pie just because everyone said it’s been profitable for 20 years.”

She advises people to look at the numbers and think about their underwriting philosophy first.

“In terms of capacity adequacy, capacity is coming in but it’s a little bit more wary than in the past,” Davies added.

Pools and standalone policies

No other class of business has the same psychological, political and emotional impact as terrorism, and that brings a different complexity to the product and to the risk, according to Karhan.

“It is different from a natural event because that’s an ‘act of god’,” she said. “In some respects terrorism feels so personally motivated that the political undertones make it very difficult as well.

“There’s a lot of political pressure for the insurance industry to provide a product and a lot of pressure for the insurance to be able to recover, and there’s not enough communication in between to find a middle ground.

“A lot of people expect if they buy insurance it should just pay out regardless.”

Victim compensation is another issue that is talked about a lot because there are “a lot of gaps between what will be paid for by insurance policies and what will be paid for by the government and no-one is ever going to be happy with what they get”, Karhan said.

There is also a huge issue with the US government Terrorism Risk Insurance Program Reauthorization Act (TRIPRA), said Davies.

“For example, the Boston Marathon bombings in 2013, which everyone would say was an act of terror, were not triggered under the TRIPRA legislation, even though I think if you’d added up all the costs involved it would have taken it over the trigger.

“It was a political decision rather than a contract decision, and that is one of the shortfalls of TRIPRA.

“We frequently say to our brokers that your client needs a standalone policy with some certainty under it. Going forward that is one of the things that concerns me about some of the pools.”

Pool Re has been one of the pools that has been “more progressive and has tried to stick with what is happening in the market”, said Karhan. But, she added, Davies is right that there are “some gaps coming up that people are not aware of”.

She said that one of the downfalls of having a major line of business that has no major losses is that people become “very complacent”.

Another problem with the class is that it’s very reactive. “When you get to the mass events, the big cats, then they’ll start to look to see what went wrong.

“Coming back to the point about the emotional and the psychological impact, it’s a really fine line between building unnecessary fear and the implications that come from that fear and being very sensible about anticipating what could happen.

“That is where, particularly in these sorts of market environments it becomes a very challenging problem to solve and gap to fill,” she concluded.

To watch the full Re/insurance Lounge panel session  click here.