Since 11 September terrorism has become a huge issue for all. Insurers are running scared and cover is scarce, Michael Faulkner reports.

While security agencies may have anticipated the nature of the terrorist attacks on 11 September, for others the destruction of the twin towers by two aircraft was beyond comprehension. Terrorism had reached new depths of abomination.

The US attacks changed the face of global terrorism and heralded the arrival of a new and frightening terrorist arsenal: aircraft, anthrax, and 'dirty' bombs. Terrorism became a major issue for the insurance market.

The scale of the losses and the manner in which the attacks were carried out caused the market to reappraise its exposures to terrorism and the extent to which it was prepared to cover these risks. As a result, many businesses have found themselves with limited or no cover for terrorism exposures.

One year after the WTC attacks there have been considerable developments in the insurance of terrorism risks. But the situation remains complex and the insurance market's approach to these risks is inconsistent.

Before 11 September, the main issue for terrorism underwriters was in relation to UK-based property, due principally to the activities of the IRA in the 1980s and 1990s. As a result, terrorism losses were routinely excluded from these risks.

But most UK commercial insurance policies gave limited cover against terrorism under the special provision terrorism clause, which gave £100,000 per head of cover - buildings, contents, business interruption (BI) and book debts - and £250,000 in respect of flats.

Business could also purchase additional cover through Pool Re, the government-backed mutual reinsurer, for property damage and BI in the UK, but only in relation to fire and explosion perils.

Top-up terrorism cover was also available through the commercial market, with a number of Lloyd's syndicates offering polices, such as so-called "difference in conditions" cover which filled the gap in insured perils left by the Pool Re scheme.

Uninsurable peril
After 11 September, the market reassessed its attitude to terrorism cover. Reinsurers were the major driving force in this process: after all, if they were not prepared to cover terrorism risks in their treaties, primary insurers would not do so in their policies.

Many reinsurers stated their intention not to cover any risks remotely related to terrorism. In their view, terrorism was now an unquantifiable and uninsurable peril that was impossible to model.

Terrorism cover was withdrawn from treaties across significant areas of the insurance industry and severely limited in others. Where reinsurance cover was offered, rating increases were significant.

Unsurprisingly, this restricted reinsurance environment had a major impact on the cover primary insurers were willing to provide.

The withdrawal of reinsurance cover greatly affected property insurance. Although insurance for UK-based property was already subject to terrorism exclusions, insurers began to impose exclusions on property outside the UK. Lloyd's syndicates also stopped offering the limited cover provided by the special provision terrorism clause. The commercial market for stand-alone terrorism cover also contracted massively.

Owners of UK-based property were still able to purchase cover through Pool Re, but this only provided cover for fire and explosion perils, leaving large areas of risk uncovered: after all losses could arise through perils such as impact, malicious damage and sabotage of public utilities.

This left many risk managers without any or only very limited cover against terrorism risks and led to calls from bodies such as Airmic for the Treasury to increase the range of cover provided by Pool Re.

But questions still remain about the precise details of the pool's operation: in particular, how individual insurers will contribute to the pool. A senior industry figure asks: "How is the premium charged, how is the information tracked, how do the limits work and will you have the option to buy down below?"

Heath Lambert executive director of international non-marine and property Steve Bessant said: "While the changes announced by the Treasury represent a significant step forward, we must keep on considering all the alternatives to keep exclusions to the absolute minimum for the benefits of our clients."

Insurers and reinsurers also became concerned that there could be circumstances in which liability could attach to insureds following a terrorist incident.

The result: some insurers began to add terrorism exclusions or limitations on cover to their liability policies.

In the past six months the market for terrorism cover on property risks has grown. Reinsurance has started to become available and insurers in Bermuda, at Lloyd's and in the Company Market are writing risks.

The new look Pool Re
In July, the Treasury announced that Pool Re would be changed to become, in effect, a treaty reinsurer for commercial property. This would involve a two-stage process.

  • The first stage came into effect on 20 August. It extended the cover provided by Pool Re from fire and explosion only to a wider all risks basis, including bio-terrorism. From 1 January 2003, nuclear contamination will be added.
  • The second stage, which operates from 1 January 2003, involves the market for terrorism insurance becoming fully competitive. Individual insurers will be able to price the cost of terrorism cover to reflect the risk and reinsurance costs. The maximum liability of insurers will also be capped per terrorist event and per year, the level of the cap for each insurer being based on its market share. Initial industry retention limits will be £30m per event and £60m per annum. The retentions will be progressively increased each year for three years.

    These changes have been welcomed. ABI head of general insurance John Parker said: "For insurers, limiting the liability arising from any single event and within a calendar year provides complete certainty of their maximum exposures at the start of each year."

    Airmic executive director David Gamble said: "I am very pleased. It was a win-win-win situation. The government achieved the flexibility it sought in terms of competition; insurers got a cap on their liabilities; and insureds got much wider coverage - wider than anywhere else in the world."

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