Perspectives – Lloyd Dixon, RAND Corporation

In the second of our two part series on terrorism, we spoke to Lloyd Dixon, senior economist at the global policy think tank, RAND. We asked him about the recent changes to the US terrorism insurance legislation, the Terrorism Risk Insurance Act (TRIA).

Following the World Trade Center attacks in 2001, the market for terrorism insurance collapsed as many market participants took the view that terrorism had become an inherently uninsurable risk. As a result, many businesses in real estate, transport, energy and other terrorism vulnerable industries were unable to obtain adequate insurance.

The US government responded in November 2012 by passing TRIA which enabled federal funds to be used to help pay claims from certain terrorism losses. It also forced insurers to provide certain types of terrorism coverage. Having been renewed in 2005 and 2007, the looming expiration of TRIA in December 2014 caused intense lobbying - most of it directed towards ensuring its continuation. Having been allowed to expire at the end of 2014, TRIA was reinstated by Congress this January

Screen Shot 2015-03-18 at 1.08.49 AM

The current legislation had been scaled-back to encourage further growth of the private market. The total size of the programme will remain $100 billion, however the minimum sized eligible event - currently at $100m - will increase by $20m each year from 2016 until a new $200m threshold has been reached.

LloydDixonThere has been some debate about the new legislation. Is it fit for purpose?

I don't think it's a major change from the previous legislation. There are some tweaks but it's quite similar in many ways. There is a general hope in Congress that ultimately this program will not be necessary.

 The key question is, if TRIA were to expire what would the response of the private insurance industry and reinsurance industry be? What you can say is that without TRIA, given the experience of 9/11 and what has happened in the wake of other catastrophes, one would expect to see a withdrawal of reinsurance capacity and a price spike, post-event. So, if TRIA were to expire and another event happened, you'd likely see some serious disruption in the market. But with TRIA in place there would be much less disruption.

It's a long way in the future and TRIA's future will depend in part on what happens in terms of the perceived risk and the world situation. When Congress set the program up initially there was a notion it would be a short-term program, and that's embedded in the design of the program.

I suspect Congress currently does not want to see a permanent program and will keep chiselling away at it as much as possible. I don't see the appetite for a permanent Pool Re-type program, but  the program is 12 years old now and will be 18 years old by the time 2020 comes around, so it's getting permanent.

Why are insurance companies reluctant to cover terrorism risk in general and NBCR in particular?

It's just so unpredictable and it's very difficult to model the risk and figure how to limit it, especially with an NBCR event, which can be so large. It can open the insurer up to insolvency if events play out in certain ways.

Terrorism risk is one that doesn't conform to the usual things you'd like to see in an insurable risk in terms of predictability. So there is a real reluctance to get involved in that market on the part of insurers.

One of the things we've pointed out over time in our analyses is that due to the nature of the risk, insurers need to hold a fair amount of capital to protect against insolvency should an event occur, and that's expensive. And then at some point policyholders don't want to buy coverage because it is too expensive and you don't have a well-functioning market.

To what extent has the risk of large-scale attacks diminished as a result of global surveillance?

There is still the possibility that you could have small numbers of people carry out attacks with destructive weapons.  If you think about Timothy McVeigh and the Oklahoma bombing - he was acting with a very small set of people and they put together the truck bomb that blew up the federal building in Oklahoma City. So it's not like a small number of people means you couldn't have a significant weapon involved.

Lloyd Dixon is director of the RAND Center for Catastrophic Risk Management and Compensation and a senior economist at the RAND Corporation. His expertise includes insurance, compensation, and liability issues. He has also been lead investigator of a number of studies addressing environmental and natural resource issues. Recent studies include analysis of the wind and flood insurance markets, asbestos litigation, the California workers' compensation insurance market, and the contribution of hedge funds to systemic financial risk.

Dixon received his B.S. in general engineering and B.A. in political science from Stanford University and his Ph.D. in economics from the University of California, Berkeley.

Posted: Monday, March 23rd, 2015