A Successful (Yet Somewhat Untested) Case of Disaster Financing: Terrorism Insurance Under TRIA, 2002–2020

• DOI: http://doi.org/10.1111/rmir.12094
• Author: Erwann Michel‐Kerjan,Howard Kunreuther
• Date: 01 March 2018
• Published date: 01 March 2018

Risk Management and Insurance Review

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Risk Management and Insurance Review, 2018, Vol.21, No. 1, 157-180

DOI: 10.1111/rmir.12094

PERSPECTIVE

ASUCCESSFUL (YET SOMEWHAT UNTESTED)CASE OF

DISASTER FINANCING:TERRORISM INSURANCE UNDER

TRIA, 2002–2020

Erwann Michel-Kerjan

Howard Kunreuther

ABSTRACT

The Terrorism Risk Insurance Act (TRIA) established a public–private partner-

ship between the U.S. federal government, private insurers, and all commercial

enterprises operating on U.S. soil. Renewed and modified in January 2015 until

December 2020, the TRIA program requiresinsurers to offer terrorism insurance

to their commercial policyholders while providing insurers with free up-front

financial protection up to $100 billion against terrorist attacks in the United

States. With the federal government providing a financial safety net, the pri-

vate insurance sector can offer coverage against an uncertain risk that would

otherwise be largely considered uninsurable, thus making terrorism insurance

widely available and affordable. TRIA is a successful case of public–private dis-

aster risk financing that has received bipartisan political support. Yetit remains

untested for large losses and it is unclear how the market and policymakers will

react should another large-scale insured loss occur. TRIA also raises concerns

about the indemnification of individual victims of a terrorist attack (in addition

to workers’ compensation).

Erwann Michel-Kerjan is a partner at McKinsey & Company; e-mail: erwann_michel-kerjan@

mckinsey.com. Howard Kunreuther is Co-Director of the Risk Management and Deci-

sion Processes Center, Wharton School, University of Pennsylvania; e-mail: kunreuth@

wharton.upenn.edu. This article was prepared for the “Improving Disaster Financing: Evalu-

ating Policy Interventions in Disaster Insurance Markets” workshop held at Resources for the

Future on November 29–30, 2016. Wethank the sponsors of this project: the American Academy

of Actuaries, the American Risk and Insurance Association, Risk Management Solutions, the

Society of Actuaries, and XL Catlin. This research was partially supported by the Center for Risk

and Economic Analysis of TerrorismEvents (CREATE) at the University of Southern California,

the Critical Infrastructure Resilience Institute (CIRI) at the University of Illinois (U.S. Depart-

ment of Homeland Security’s Centers of Excellence), Resources for the Future, and the Wharton

Risk Center’s Managing and Financing Extreme Events project. Carol Heller provided excellent

editorial assistance. Wethank Christopher Lewis, Robert Muir-Wood, and Gordon Woo for their

involvement in an earlier study on loss sharing that this article discusses. Wealso benefited from

insightful comments from Lloyd Dixon, Richard Ifft, Jim MacGinnitie, Tom Santos, and other

participants at the November 2016 RFF-Wharton workshop in Washington, DC.

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158 RISK MANAGEMENT AND INSURANCE REVIEW

GENESIS OF THE TERRORISM RISK INSURANCE ACT PROGRAM

Terrorism has been a persistent threat in many parts of the world for decades; the

first major terrorist attack in the United States occurred in February 1993. The terrorist

organization Al Qaeda detonated a large truck bomb in the garage of the North Tower of

the WorldTrade Center (WTC) in New York City, closing Tower 1 for 6 weeks and Tower

2 for 4 weeks. Although the building did not collapse (as the terrorists had planned), the

attack killed six people and caused over $750 million in insured losses (Kunreuther and

Michel-Kerjan, 2004).

In April 1995, Timothy McVeigh detonated a bomb outside the Alfred Murrah Federal

Building in downtown Oklahoma City,killing 168 people and injuring another 700. This

attack damaged 324 buildings within a 16-block radius and resulted in about $650 million

in damage. The federal government owned the main building and self-insured against

potential losses so there were no claims filed with private insurers. The Oklahoma City

bombing demonstrated that the terrorism threat could emanate from domestic sources

and that a successful attack could inflict massive losses with readily available materials

and not a great level of sophistication.

Then came the devastating coordinated attacks by Al Qaeda on September 11, 2001. The

attacks killed over 3,000 people and injured another 2,250 and resulted in record insured

losses of nearly $45 billion, now second only to Hurricane Katrina as the most costly

insured disaster in the world (in 2016 prices) (Wilkinson and Hartwig, 2010). Due to

the international nature of insurance and reinsurance markets, nearly 120 insurers and

reinsurers, many of them headquartered outside of the United States, paid these losses.

There have been a number of recent publications on terrorism risk insurance (Hartwig

and Wilkinson, 2013; Dworsky and Dixon, 2014; LaTourrette and Clancy, 2014; Willis

and Al-Shahery,2014; Michel-Kerjan et al., 2015); insurance industry reports on the take-

up rates and terrorism pricing (AON Benfield, 2013; Marsh, 2013) and other topics by

the U.S. government and international organizations (President’s Working Group on

Financial Markets, 2010, 2014; Congressional Research Service, 2013, 2014; Government

Accountability Office, 2014; OECD, 2005, 2010). What is absent in this literature is a rig-

orous scientific approach for determining the economic losses associated with different

credible modes of attacks against specific locations in the United States that quantifies

how those losses would be shared among different stakeholders, namely, American

taxpayers (the federal government), insurers, and commercial firms whether they are

insured against terrorism or not. This will be a focus of this article.

We first discuss the need for a public–private partnership that has made terrorism cov-

erage widely available and affordable, given most insurers’ refusal to provide terrorism

coverage following 9/11, which left American corporations largely uncovered and the

government de facto liable should relief have to be provided after an attack. We then

briefly outline the current risk-sharing structure under the Terrorism Risk Insurance Act

(TRIA) and characterize expected losses from three types of terrorist attack scenarios—

one conventional (10-ton truck bomb) and two nonconventional (sarin contamination

and nuclear explosion)—in downtown Chicago, Illinois; Houston, Texas; Los Angeles,

California; and New York City, New York, using modeling capability of the modeling

firm Risk Management Solutions (RMS). We quantify the loss distribution across stake-

holders under different scenarios, loss levels, and locations of the attack. Combining