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To Pay or Not to Pay: Business Weighs the Cost of Terrorism Coverage

Confronted with high premiums and their own skepticism about whether such coverage is necessary, many managers are deciding against terrorism insurance.

Nearly two years after the terrorist attacks of September 11, 2001, businesses continue to evaluate the threat of another catastrophe and try to gauge their own exposure to it.

Their perception of the risk is conditioned by periodic terrorist attacks abroad, fears of reprisals for the U.S. invasion of Iraq, the federal governments intensive work on terrorism and an underlying insecurity that may now be a permanent feature of the national psyche.

But none of that has translated into a rush for coverage, according to participants at "Assessing and Managing Extreme Events," a roundtable for insurers, reinsurers, academics and modelers held by Wharton s Risk Management and Decision Processes Center on April 28. The event focused on the challenges facing the insurance industry, government and modelers in seeking to manage the risk of terrorism and other extreme events such as natural disasters.

A majority of insurance brokers says that fewer than 10% of their small commercial property clients and under 20% of medium-sized accounts have purchased terrorism coverage since federal legislation required insurers to start offering it last November, according to a survey by the Council of Insurance Agents & Brokers (CIAB), a trade group, published March 24.

Even in New York, one of four cities given a "Tier 1" rating by the insurance industry for the highest risk of another terrorist attack, only about one in eight commercial clients are adding terrorism coverage to their policies, according to John DeMartini, senior vice president at Towers Perrin Reinsurance, a broker in Stamford, CT.

About one in three or four New York City businesses are placing initial orders for terrorism coverage, but about half of those decide to cancel "when they see the bill," he added.

Because it is difficult to quantify terrorism risk, some managers are not paying enough attention to the issue, noted conference chairman Howard Kunreuther, co-director of the Wharton Risk Management Center. They need to abandon the view that "Im not thinking about this and I m not putting my money into something I dont think is going to happen," he said.

Terrorism premiums nationwide add about 10% to the cost of existing insurance policies for small and medium-sized companies, and 20% or less for large accounts, according to the CIAB. But the costs are predictably higher in those cities -- New York, San Francisco, Washington, D.C. and Chicago -- that have been classified as a "Tier 1" risk.

One broker quoted by another trade group, the Independent Insurance Agents & Brokers of America, reported a 17% loading for terrorism coverage on apartment buildings in The Bronx, N.Y. Significantly, the client declined the coverage, which would have cost $18,000 a year.

Another broker seeking terrorism coverage for a building in San Francisco received a quote that would have doubled the client s existing $600,000 premium for earthquake insurance, according to the February survey. Again, the coverage was declined pending the receipt of further quotes. An insurance wholesaler in Wisconsin, by contrast, reported terrorism loadings of between 4% and 10% on existing policies.

"Small, relatively low-profile accounts seem to be able to find terrorism coverage at a reasonable cost but many are opting not to buy it because they dont think they are at risk," said CIAB President Ken Crerar in a statement accompanying the survey. "On the other hand, some of the riskier operations, with real exposures, choose to do without coverage because of the cost."

Insurers are now required by the Terrorism Risk Insurance Act to offer coverage against foreign, but not domestic, terrorism. The federal government has agreed to underwrite most of the risk for the three-year life of the Act as a substitute for the reinsurance industry, which largely withdrew from coverage after suffering about three-quarters of the $40 billion losses stemming from the September 11 attacks.

Overall, insurers seem to be following guidelines for terrorism pricing published by the New Jersey-based Insurance Services Office, an advisory company to the industry, said spokesman Dave Dasgupta. For Tier 1 cities, the guidelines recommend a premium of 3 cents per $100 of coverage. For the Tier 2 cities of Philadelphia, Seattle, Los Angeles, Houston, and Boston, the premium is 1.8 cents, and for Tier 3, representing all other areas, the premium is 0.1 cent.

"Opportunistic Pricing"

As primary insurers look to spread their risk, reinsurers are seeking to offset their September 11 losses with some "opportunistic" pricing, the Wharton conference heard. A sample cover quoted by DeMartini as being representative of the market showed one insurer agreeing to pay a premium of $900,000 for $9 million worth of terrorism coverage. This 10% "rate on line" is dramatically higher than the generally agreed probability of a terrorist attack occurring, DeMartini said. Thats more likely to be about 0.5%, on which a reinsurer would normally charge a small technical margin.