The economic cost of the 7 July London bombings has been estimated at more than $1 billion
The extent of the damage to the London Underground and the country's tourism industry during and after the 7 July attacks has been estimated at nearly $1.1 billion. The incident was a reminder of the thorny issues surrounding insurance and terrorism, a reminder that is all the more pressing because the U.S. Terrorism Risk Insurance Act (TRIA) is due to expire at the end of this year.
The 7 July London underground bombing on 7 July cost an estimated 600 million pounds ($1.08 billion) in lost tourism and transport revenues according to scotsman.com. The lost revenues for the transport system are to be covered from London’s Transport Reserve Fund. The material damage to the London subway system itself is estimated at $100 million and will be covered by the British government-backed terrorism-insurance scheme, Pool Reinsurance (Pool Re) according to the website of "Claims Magazine."
Pool Re, which was established in 1993 in response to terrorist attacks by the Irish Republican Army (IRA), covers damage from terrorist attacks by making insurers liable for up to $237 million per attack, while Pool Re covers the remaining costs. Pool Re covers claims up to $6.3 billion; the U.K. treasury is expected to step in for amounts beyond that.
The End Of TRIA?
The July events in London have focused attention on TRIA, which was passed by the U.S. Congress in November 2002 and is due to expire on 31 December 2005. What this could mean for America’s economic well being and national security is being hotly debated by think tanks and the insurance industry.
TRIA was passed in the wake of the 11 September 2001 terrorist attacks in the United States, which ultimately cost insurance companies some $32.5 billion.
According to the provisions of TRIA, if damage claims exceed $5 million and if the treasury secretary deems the incident a terrorist attack, then TRIA will pay 90 percent of the value of claims. In order to qualify under TRIA, the attack must be carried out by a foreign entity. Payments for nuclear, biological, chemical, or radiological attacks are not covered by TRIA.
TRIA, however, has not actually paid out any money since its inception and has arguably been more of a psychological tool in the war on terrorism then a full-fledged government reinsurance mechanism. It has reassured business that the government will be there to cover catastrophic losses from a difficult-to-predict act of terrorism. This has helped boost confidence in the U.S. economy.
After the 11 September 2001 attacks, it was feared that many insurance carriers would stop covering damages from terrorist attacks, which previously was generally included in standard property and casualty policies. These fears, however, proved largely unfounded, although many companies did raise the premiums for terrorism coverage.
However, there is at least some evidence that TRIA helped stabilize the situation following the attacks and that it reduced costs for some businesses. The American Hotel and Lodging Association reports on its website that "following passage of this legislation [TRIA], one hotel company reported a drop in insurance costs, which was initially quoted to range from $72,000-$95,000 annually, to less than $2,000 annually."
Nonetheless, a June report by the US Treasury Department entitled "Assessment: Terrorism Risk Insurance Act Of 2002" concludes that: “Consistent with its original purpose as a temporary program scheduled to end on December 31, 2005, and the need to encourage further development of the private market, the Administration opposes extension of TRIA in its current form.”
Disputing The Treasury
The Rand Corporation in a 2004 study entitled “Issues And Options For Government Intervention In The Market For Terrorism Insurance” presented arguments why Congress should not only extend TRIA, but expand the guarantees it offers to include coverage of attacks by domestic terrorist groups and attacks using nuclear, biological, or chemical weapons.
The Treasury Department's June report partially acknowledged this problem and estimated that one-quarter of policy holders might lose terrorism insurance if TRIA is allowed to expire. Nonethless, the department apparently feels the private sector is robust enough to absorb possible claims.
The scale of the 11 September 2001 attacks demonstrated that modern terrorist attacks can cause severe damage, way beyond anything that had come before, making risk assessment and premium determination highly problematic.
The extension of TRIA is directly related to this question: Does the U.S. government feel secure enough from foreign terrorist attacks to allow private insurance companies to take the full financial risk themselves?
The TRIA debate centers in part on the ability to model terrorism risk for the insurance industry. One leading approach, known as probabilistic modeling, attempts to measure terrorist behavior and the possible types of attacks, and then decide which targets “present the lowest technical, logistical, and security barriers to [terrorist] mission success,” according to the Treasury Department report. Insurers then assign a probability to the location and the scenario.
After 11 September 2001, several companies developed software that purportedly allows insurers to identify their exposure to terrorism risk in various countries around the world. However, there is not yet any reliable information on the accuracy of such assessments.
The Treasury Department report acknowledges that risk modeling has serious drawbacks and is far from a precise science. “Because of the difficulty inherent in assessing the probability of attack, use of terrorism predictive models is tempered by the large degree of uncertainty in their predictions," the report admits.
The Economic Impact Of TRIA Expiration
The question of what might happen if TRIA is allowed to lapse after 31 December and what impact this might have on the U.S. economy was discussed on 8 July at the American Enterprise Institute (AEI) in Washington.
Chris Lewis of the Hartford Financial Services Group presented the following scenario: A 10-ton truck bomb exploding in central San Francisco is estimated of having the capability of creating some $15 billion of damage - however, the impact on GDP could “be as high as a loss of $235 billion over a one year period.” Without TRIA “the losses could be 25 percent -- or more -- higher,” Lewis stated.
A 2004 study entitled "Economic Effects Of Federal Participation In Terrorism Risk," which was commissioned by the American Insurance Association and five other insurance-industry trade groups that favor a TRIA extension, states that: “Even in the absence of another major terrorist attack, U.S. gross domestic product (GDP) may drop 0.4 percent, or $53 billion, due to the lack of a federal terrorism insurance backstop. It also would cut into new job creation by 0.2%, or 326,000 jobs,” the website the "National Real Estate Investor" reported on 15 September 2004.
Participants in the AEI panel discussion also pointed out that many companies refused to buy terrorism insurance covering nuclear, biological, and chemical attacks in 2004, arguing that they feel they do not need it and that it is too expensive. The Treasury Department study reported that "the vast majority of policyholders without terrorism coverage reported that they felt they were not at risk.”
Despite the Treasury Department's vote of no confidence, most experts believe TRIA will be extended in some form past the end of this year. Advocates argue that doing so will enable the industry to improve terrorism risk-assessment models while maintaining the economically important psychological assurance that the government will provide automatic assistance in the event of a catastrophe.