We Can Write Terror Risk, Industry Execs Say

November 7, 2013 by Susanne Sclafane

At least two property/casualty insurance and reinsurance industry executives highlighted the industry’s capacity to write terrorism coverage during recent earnings calls, with the most forceful assessment coming from the chairman of Validus Holdings late last month.

“We think the industry doesn’t service itself well by claiming that terrorism risk can’t be priced and modeled effectively—with the exception of NBCR,” said Validus Chair and CEO Ed Noonan on an Oct. 25 earnings conference call.

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Breaking away from a discussion of Validus’ report of $183.4 million in third-quarter income to offer the commentary on terror coverage for risks other than nuclear, biological, chemical and radiological events, Noonan said, “We’re one of the world’s largest terrorism insurers and reinsurers,” referring to insurance offered from Validus’ Talbot Holdings in London and reinsurance from Bermuda-based Validus Re.

“We’ve spent a tremendous amount of time creating robust risk modeling and management tools that do, in fact, enable pricing of conventional terrorism risk,” he said.

“The argument that we can’t underwrite conventional terrorism is a classic example of driving business out of the market and into governmental solutions,” he asserted. “Think about the National Flood Insurance Program.”

Noonan’s comments stand in stark contrast to those offered by industry representatives before the House Committee on Financial Services in September about the need to extend the federal terror insurance backstop under the Terrorism Risk Insurance Program Reauthorization Act (TRIPRA) before it expires at the end of 2014.

Testifying before the committee, for example, Eric Smith, president and CEO of Swiss Re Americas, said that in order for the private insurance marketplace to underwrite and price risk, “it must be measurable [and] have loss occurrences that are largely independent,” noting that terrorism risk fails on these and other conditions.

“Despite the best efforts of modelers, terrorism risk remains unmeasurable today, largely because of the intentional nature of a terrorist attack,” Smith said, contrasting natural catastrophes, which are “random with uncorrelated outcomes [of] underlying physical processes or phenomena” for which a steadily growing body of data exists for model development.

“The models that do exist have not been tested, so we don’t have the same level of confidence in terrorism models that we would have in models for other types of perils,” he added. “There is no effective basis for assessing the likelihood, location or type of a terrorist attack.”

During the Validus earnings call, Noonan countered the arguments. “The question isn’t whether [terror risk] can be priced but rather the precision of the parameters in a pricing model,” he said, noting there is good data available on damageability for various blast sizes.

Conceding that “frequency doesn’t have a rich data set,” Noonan argued that “there are many other classes of risk that suffer the same shortcoming, and the industry uses simulation tools” to inform judgments about frequency.

In fact, the lack of frequency data does not prevent the reinsurance market from pricing terrorism today. “It’s a $40 billion market in terms of limit purchase,” he reported on the conference call.

Agreeing with Smith that commercial terrorism models “have only limited value” and geographical limitations, Noonan said that Validus and other companies have developed their own tools, such as “spider mapping” to track exposures. “We’ve gone further and built a database that divides the world into 4.4 million individual grids for aggregate and total insured value tracking,” he added.

“With better discipline around data collection, data scrubbing and exposure tracking, the industry can and should take on the risk of conventional terrorism,” he concluded.

Noonan ended his prepared remarks by saying that Validus will be watching Washington closely, as did Kevin O’Donnell, president and CEO of RenaissanceRe Holdings Ltd., during his company’s earnings call on Wednesday of this week. After reporting on RenRe’s $179.7 million of net income in the quarter and reinsurance market conditions, O’Donnell briefly referred to the company’s focus on TRIPRA’s expiration.

“With better discipline around data collection, data scrubbing and exposure tracking, the industry can and should take on the risk of conventional terrorism,” says Validus’ Ed Noonan.

“We have historically been a large provider of both international and U.S. terrorism coverage. We have the people, technology and capital to write this risk and believe that if demand for this product increases, capacity will be there to meet it,” O’Donnell said.

During the Validus call, Noonan carved out the NBCR category of risks from his statements about terrorism insurance, noting that the industry cannot address NBCR today. “The breadth of the potential events are either unknowable or could potentially bankrupt the market,” he said. He added that cyber terrorism is similarly uninsurable, as “the scope, duration, potential damage and economic loss from cyber terrorism is currently unknowable.”

“But conventional terrorism is a reasonable risk class at this point, and there’s no reason that the industry should be pushing that onto the federal government in our view. That should create more opportunity for people like us and other reinsurers.”

Weighing in on what he views as the likeliest congressional actions on TRIPRA, Noonan said that one would be renewal with higher industry deductibles and copayments—a move that would induce carriers to buy more reinsurance to protect their risk. The other approach “that we think makes sense” would take the government out of insurance for “conventional terrorism” completely, putting the government program’s focus solely on dealing with NBCR and cyber terrorism. That also creates a lot of demand for reinsurance, he said.

Noonan also predicted that insurance-linked securities around terror risk will start being packaged soon. “We do know investors in the ILS market today who would like to take that risk. And so it won’t take very long for that to start to provide the high-layer type of capital required.”

Later in the call, Noonan responded to a question about whether third-party capital could support the National Flood Insurance Program, which drew a strong response about the role of government in flood insurance.

“Let me start with a declarative sentence: NFIP should not exist. The private industry can easily cover that risk,” he said.

Reviewing the recent history of the program, which is attempting to move to sound rates after years of charging rates that were too cheap in many places, he said, “You end up with this guillotine pricing effect, where suddenly people are looking at multiples of rate increase—three, four, five, 10-times last year’s premium.”

“Private industry does that better,” Noonan said, noting that not only is it likely that the industry would have been charging more adequate rates historically, “we certainly wouldn’t try and increase premiums five-times or 10-times [higher] in a year. We would have phased it in over time.”

“There is absolutely no reason” for a government flood insurance program. “The capacity exists in the private sector. The reinsurance market can handle it. If the ILS capital is needed or attractive, we’ll access it and bring it to the class.”