Supply Chain Response to Global Terrorism: A Situation Scan Insurance and Risk Management Response

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Supply Chain Response to Global Terrorism A
Situation ScanInsurance and Risk Management
Response

• A Research Project Update to
• ISCM Sponsors
• by
• The SC Response to GT Team
• October 16, 2002

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Outline

• Terrorism and the Insurance Industry
• Defining the problem.
• Risk Management
• Modeling Solutions
• The Future
• New Modeling Solutions

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Foundation of Observations To Date

• Print References
• 1400 pages of Insurance/Risk Mgt Industry
  reports
• 2 Books
• When All Else Fails (David Moss Harvard Business
  School)
• Making the Nation Safer (National Research
  Council)
• Relevant Journals, Periodicals, Research Papers
• E.g. Risk Analysis, Journal of Risk and
  Insurance, Journal of Risk and Uncertainty.
• On-Line References
• 50 Insurance Industry Websites
• Interviews
• 11 interviews with Terrorism/Risk/Insurance
  Experts
• Assistance from 3 Consulting Firms
• Seminars
• 2 Seminars on 21st Century Terrorism in the U.S.

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Defining the Problem

• September 11 changed the underlying assumptions
  of terrorism risk and insurance economics.
• 56B estimated losses from WTC exacerbated a
  previously existing problem
• Unsatisfactory return on capital for insurers
  before 9-11-01
• Much of the loss will be paid out of the industry
  capital account
• Result
• Coverage eliminated on many policies after 1-1-02
  renewal date
• Premiums raised on other policies for
  substantially less coverage
• Impact on commerce
• Airline industry to pay 1B premium increase in
  02
• Increased risk aversion has negative impact on
  economy
• E.g. Some lenders are assessing properties for
  terrorist risk, and are not lending to trophy
  properties not adequately insured

Per US Dept. of Transportation
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The Crux of the Problem

• The potential damages have been revealed to be so
  high that the US Government has a new role
• There is no company or group of companies that
  has the resources to assume such a risk, even
  though all concerned have unthinkingly been doing
  so. The only viable re-insurer for truly
  large-scale terrorism is the U.S. Government.
• E.g. If the attack in NY were nuclear, damages of
  1T total far exceeds the aggregate capital of
  the world's insurance companies

Source The Chairman Warren Buffett
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Potential Solutions

• Shared Loss Compensation Program
• Proposed by Treasury Secretary Paul ONeill
• Program between private insurance companies and
  the Government.
• Government will assume a significant percentage
  of the liability for the next terrorist attack.
• Government involvement would sunset after 2004
• A temporary solution, limiting Government
  involvement
• Concept is to provide Insurance industry time to
  develop a new risk management scheme that
  incorporates terrorist activities

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Shared Loss Compensation Program

• (2002) GOV 80 of 1st 20 Billion 90 of 20
  Billion
• (2003) GOV 00 of 1st 10 Billion
• 50 of 10B 20B
• 90 of 20 Billion
• (2004) GOV 00 of 1st 20 Billion 50 of 20B
  40B
• 90 of 40 Billion

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Assessing The Risk As We Now Know It

• Swiss Re officials speculate
• It could take three to five years for the private
  insurance industry to develop the means to cover
  terrorism
• Using an approach that is similar to that used
  with natural catastrophe risks
• The Risk as We Now Know It
• Historically, terrorist groups seeking to attack
  the U.S. generally target business.
• Since 1968 when the government first started
  tracking terrorism, 80 percent of attacks on U.S.
  interests have been on businesses
• Models actively used to analyze and assess

Ambassador L. Paul Bremer, Chairman of the
Crisis Consulting Practice at Marsh, Washington,
D.C.
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Assessing the Risk

• Commonly-held opinions in the industry
• Terrorism risk is not insurable because it cannot
  be quantified
• Modeling companies and insurers, however, are
  beginning to develop new tools for analyzing the
  risk in the hopes of bringing clarity to the
  process
• Modeling Solutions
• First define the problem
• The next step involves soliciting various
  perspectives
• Interviews with leaders from industries and
  government
• Focused research on potential solutions

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Modeling Solutions Four Key Issues

• Where attacks might occur
• What form attacks might take
• What the probability is for a particular attack
  on a certain location
• I.e Modeling the terrorists.
• How to translate such an attack into damages

Per Guy Carpenter
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Modeling Solutions Three Service Waves

• First Wave
• Customized exposure mapping and scenario analysis
  with Geographic Information Systems (GIS)
• Highlight certain buildings or infrastructure
  features as potential targets, then see how
  exposures are distributed
• Second Wave
• More formalized tools for accumulation control,
  building on GIS by automating what-if scenarios
  and making tools more user-friendly
• E.g If a car bomb were set off at a certain
  location, what would be the consequences for a
  particular set of insured exposures?
• Third Wave
• Complete probabilistic models
• Much more sophisticated and similar to the models
  currently used with hurricanes and earthquakes

Per Guy Carpenter
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Three Largest Risk Modelers

• Applied Insurance Research (AIR)
• Extends its existing natural catastrophe models
• Catastrophe modeling firms have inventories of
  commercial residential building stock, info
  on infrastructure (bridges, tunnels, port
  facilities, etc.)
• Eqecat
• Uses a pure probability model with property
  damage functions based on historical and test
  data
• RMS
• Game theory approach model future targets by
  understanding operational and behavioral
  characteristics of terrorist organizations

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RMS Solution

• RMS Terrorism Risk model supports high-resolution
  analysis at latitude/longitude or street address
  level.
• Estimates the probability and cost of property
  damage, business interruption, and casualties
  caused by 16 different 'modes' of terrorist
  attack
• Includes conventional explosives and weapons, and
  chemical, biological, radiological, nuclear
  scenarios.
• E.g. Based on understanding that Bin Laden is
  rational. He is a Saudi citizen who wants to
  remove the King but is unable to do so because of
  US interference.

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Target attack vs. Smaller attack vs.
Biological/Chemical attack.
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Eqecat Solution

• Eqecat has developed a model on the basis of pure
  probability. Used consulting firms to quantify
  the likelihood of an attack on a specific target.
  Those targets are assigned a hierarchical value
  .
• Over 10 million events and hundreds of thousands
  of high probability terrorism target sites.

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AIR Solution

• AIRs approach involves extending its existing
  natural catastrophe models to deal with
  terrorism.
• The model selects hundreds of thousands different
  targets and attack possibilities.
• Specialists in terrorism help choose these
  targets. From this database, probabilistic losses
  are determined.

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How is damage being calculated?
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Can Terrorism Risk Be Modeled?

• Skeptics say that the main reason why terrorism
  risk cannot be modeled is that historical data is
  needed.
• For example, when natural catastrophes are
  modeled, many criteria are taken into account but
  historical data is crucial. A probabilistic model
  cannot be created without it.

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Models All Based on Historical Data

• Eqecats probabilistic model property damage
  functions are based on historical and test data.
• AIR gets information from its location database,
  applies the specialists knowledge, and from this
  generates probabilities.
• RMS based on game theory, which suggests that
  the targets of future attacks and likelihood of
  success can be modeled by understanding
  operational and behavioral characteristics of the
  terrorist organizations.

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Shortcomings

• All three models assume TARGETS.
• Very little consideration is given to bombing a
  daycare center or a school.
• Even a Chemical-Biological-Radiological (CBR)
  attack is based on the assumption that it will
  occur in a heavily populated target location.
• No consideration for a terrorist who assembles
  and detonates a Weapons-of-Mass-Destruction (WMD)
  in the privacy of their apartment.

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New Modeling Solutions

• The Lowtan Plan for Modeling Risk
• (Still adapting from undersea to above ground)
• NOT YET AVAILABLE
• But there are other solutions being considered.

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Some Proposals for New Solutions

• Accept view that no company (or group) is capable
  of assuming the risk of insuring the potential
  damage from a nuclear WMD.
• If a terrorist detonated one nuclear device, it
  would only cost U1 Trillion. What if 3 or 4
  devices were detonated?
• Insurance companies could adopt the attitude that
  the Government designed and built most nuclear
  WMDs, so it the Government should assume
  responsibility.
• Offer a variety of insurance packages to various
  businesses with or without terrorist risk
  policy.
• Model several options that separates between
  large and small scale attacks, insure against
  different attacks.

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Some Proposals for New Solutions

• Develop a simple, understandable manageable
  spreadsheet model for insurance companies to use
  to set premiums.
• Allow individual customer companies to choose
  which terrorist package is appropriate for their
  business.

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Requirements for New Solutions

• Industry needs to be able to trust the insurance
  system to remain solvent after a crisis.
• Otherwise, what is the point of purchasing
  insurance?
• Terrorism Risk can turn into a profitable venture
  for insurance companies.
• In turn, businesses can have more faith in the
  insurance industry.

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Questions for Industry

• How does your firm think about the role of the
  Government acting as insurer of last resort?
• How is your firm modeling risk in its supply
  chain?
• How is your company protected and insured against
  an attack on your supply chain?
• Targeted disruption of distribution system
• Targeted disruption of production and supply
  system
• How is your company protected and insured against
  an attack on your products?
• Targeted product contamination

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Thank You

• Questions or Comments?

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Companies Providing Valuable Assistance

• International Security Technology, Inc.
• RMS (Risk Management Solutions)
• PricewaterhouseCoopers
• FTI Consulting
• MIT Security Studies Program Office

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Online Resources

• Berkshire Hathaway
• Guy Carpenter
• Tillinghast Towers Perrin
• Risk and Insurance