Terrorism remains a difficult risk to insure, but, contrary tothe views of some, it can be modeled by measuring the likelihood ofan attack against vigorous counter-terrorism efforts employed byWestern nations, according to a Risk Management Solutions whitepaper meant to inform stakeholders as they debate a Terrorism RiskInsurance Act extension.

In fact, the white paper argues that terrorism insurance itselfis really insuring against the failure of counterterrorism. “Thefrequency of such failures is low because of concerted suppressivewestern government counter-terrorism measures, which are stepped upeven further after any successful act of terrorism,” RMS says.

The key to modeling the risk, RMS says, is to model terroristactivity at a strategic level, rather than a tactical one. “Dealingwith terrorist operations at a tactical level is a task forgovernment officials, not risk-modeling agencies,” RMS notes.

For its part, RMS says it models the risk as a “control processby which terrorist operations are countered by security andintelligence services.” The modeler adds that the task of the riskanalyst is to assess the likelihood of an event occurring, not topredict or prevent an attack.

Given the robust counter-terrorism efforts in the West, RMS saysthe annual volatility in terrorism losses involving conventionalweapons “is actually lower than for natural hazards.”

RMS explains the probability of multiple severe nat cat eventsoccurring in a single year is “highly uncertain,” whereas “thepossibility of a wave of successful terrorist attacks against theU.S. homeland in a single year is extremely remote” due to thecounter-terrorism response that would follow any successfulattack.

The white paper frequently compares and contrasts terrorism riskand natural catastrophes. On one hand, RMS says the financial riskof terrorism is comparable to that of nat cats, noting that returnperiods commonly used in the reinsurance industry for severe winterstorms and convective storms, such as 1-in100, 250 and 500 years,can also apply to terrorism. “At longer return periods, financialimpacts can be comparable with earthquakes and hurricanes,” RMSexplains.

But the terrorism and nat cats differ when looking at a givenlevel of risk with respect to rare events with extremely highseverity. “Many natural catastrophes occur with relatively highfrequency, the range of possible damages are better understood andinsurance companies can more accurately underwrite their losspotential,” RMS says. “Successful large-scale terrorist attacks,however, are events that may only occur once a generation orless.”

The most severe attacks, involving nuclear, chemical biologicalor radiological attacks (NCBR), “may cause hundreds of billions ofdollars of damage, but have an extremely low frequencyattached.

Additionally, RMS notes that a nat cat will occur over awidespread area. During Hurricane Katrina, for example, everycounty in Mississippi and Louisiana, 22 counties in Alabama and 11in Florida were declared federal disaster areas. During a terroristattack, the damage is concentrated and may be measured in squareyards.

Chris Folkman, terrorism risk expert at RMS, tells PC360 that,because it can be modeled, terrorism can, in fact, be effectivelypriced, and he says a number of carriers are effectively modelingand profitably insuring terrorism risk today.

Still, though, he says, “There is a high uncertainty regardingcertain types of terrorist attacks,” and he mentions NCBR attacksas an example.

Regarding conventional attacks—bomb attacks—Folkman says therange of damage is much better understood, and RMS has been able tovalidate its models against historical explosions.

On the larger TRIA debate, Folkman says RMS' role is to“quantify risk as best as we can. We don't hold opinion for oragainst” an extension.

He notes though that many industry members have stated theywould be hesitant to offer terrorism coverage without thebackstop.

Models give insurers a good understanding of the risk he says,but some insurers feel the magnitude of some types of attacks couldbankrupt the industry.