Insurance companies have decades or even centuries of experience insuring against many perils, from storms to fires. But some risks are harder to insure against than others. Some perils occur too infrequently to have high confidence in any calculated probability of occurrence. Others can cause extremely extensive damage when they do occur. Still other perils can be the result of political risks that can evolve quickly. Terrorism risk, or at least those acts of terrorism that can cause the most damage, have all of these characteristics.
When the Troubles, a decades-long religious and political conflict in Northern Ireland, spilled over onto the British mainland with increasingly destructive effect in the 1990s, it challenged the market for terrorism insurance. In the end, government intervention through a new insurance organization called Pool Re was resorted to so that terrorism insurance could continue being provided at reasonable cost.
St. Mary Axe
By the mid-1990s, terrorism related to the Troubles in Northern Ireland had been ongoing for years. Attacks by the Provisional Irish Republican Army (IRA) attempted to frighten the British government into withdrawing from what the IRA saw as occupied Irish territory. These attacks caused increasing amounts of damage with time. In Northern Ireland itself, the British government had already accepted responsibility for covering losses due to terrorist attacks, compensating the owners of properties lost to terrorist incidents since 1973. By the mid-1990s, the cost of this assistance to the government had been in the area of £600 million.
However, that was the cost of compensating the victims of terrorism in Northern Ireland alone and such attacks were also becoming more common in Great Britain by the mid-1990s. A single bombing on St. Mary Axe in London in 1992 saw early estimates of damages of £800 million, exceeding the cost to the government of all attacks in Ireland up to then. In the end, it was a loss to commercial properties of ‘only’ £350 million that materialized. Still, it was an event that went on to transform the market for terrorism insurance coverage in Britain.
On November 12, 1992, the Association of British Insurers (ABI) issued a press release. It announced that the organization had issued to its members recommended wording for insurance contracts that would exclude terrorism coverage. The press release suggested that reinsurers had essentially forced the exclusion. The reinsurance companies are essentially the insurers of insurers and take on some of the liability ceded to them by their clients for a price.
The Continental European reinsurers, starting with Munich Re, did in fact begin to eliminate coverage for terrorism from its contracts and British reinsurers soon did the same. In the past, insurers had not considered that losses from terrorism would be high so coverage had been included in typical policies for commercial property insurance, but the times had changed. If the reinsurance companies would no longer cover terrorism risk, then it was more difficult for individual ‘primary’ insurers to do so since reinsurance is the common means by which they reduce the risk of large idiosyncratic events. If reinsurers began to deny coverage for acts of terrorism, the primary insurers were likely to follow, and end consumers would soon be unable to find terrorism insurance at virtually any price.
Terrorism is a difficult risk to insure against. Firstly, terrorist attacks can cause large damages since they are often designed to do just that by their initiators. They are deliberate and not accidental. It is also a form of political risk, it is actions of governments that motivate terrorists and as such, they can go from being unaccustomed to frequent, as they had in Northern Ireland during the Troubles. This also makes terrorism a very regime-dependent risk where the occurrence of such events cannot simply be predicted by calculating simple averages from historical experience.
Further, definitions of terrorism that are likely to be used in an insurance setting often involve identifying the motives of the assailants. This is problematic and can make distinguishing acts of terrorism from some other incidents more difficult. For example, does the aim of terrorists need to be to intimidate governments? What about companies? Would acts of violence against agricultural firms by animal rights or environmental activists be considered terrorism, even if it isn’t clear the attackers had any anti-regime sentiments. In any case through, terrorism risk is one peril for which objective probabilities of occurrence are difficult to measure, where individual claims can be large, and the risks concentrated.
The reinsurers were unlikely to reverse their decision after another outbreak of attacks, this time seeing several small devices explode in December 1992. The industry was rapidly turning against continued provision of terrorism coverage just as the reinsurance renewal season began. By the end of the year and just over one month after the ABI press release, Michael Heseltine, then the President of the Board of Trade, announced that the British government would be willing to act as a terrorism insurer of last resort.
Under this new scheme, the government was to act as a reinsurer to a mutual insurance company counting insurance firms and Lloyd’s of London syndicates as customers. The state intervention was intended to be only temporary, supporting the industry until the market were again in a position to cover terrorism risks.
London’s Bishopsgate bombing of April 1993, one of the largest of the era, accelerated the legislative process to implement the new government-backed reinsurance scheme. The Reinsurance (Acts of Terrorism) Act of 1993 received royal asset on May 27 that year and the government signed a reinsurance ‘retrocession’ agreement with the newly created Pool Reinsurance Company Limited (or ‘Pool Re’), just formed by the government and the ABI.
The British government was essentially agreeing to insure losses in excess of the £100,000 cover provided by the typical commercial policy, Pool Re’s reserves, and certain limited amounts Pool Re was able to require members of the mutual to pay into the company on demand. The company would cover commercial property and business interruption in the UK outside Northern Ireland, the latter having its own government compensation program already in place.
Under the retrocession agreement, any state support would later be subsequently repaid by future premiums, thus using government support to smooth out the cost of providing such coverage. This kept premiums affordable, avoiding the typical increases in rates that follow a disaster. The highest premiums were paid by certain London postcodes while the rest of Britain outside London and certain other prominent towns and cities paid less. Discounts could be had by installing sprinklers in buildings and implementing disaster recovery plans. Application forms for terrorism coverage asked such unfortunately relevant questions as ‘Are all the windows strengthened or protected by other means?’ and ‘Have refuge areas been identified for evacuation?’.
While differences in risk may have encouraged property owners or primary insurers to select only those assets that were likely targets for obtaining coverage from Pool Re, there were mechanisms in place to avoid adverse selection. Insurers buying reinsurance from the company were required to do so against all insured property and not specific assets. Insurers in turn required their customers insure their properties against terrorism either in their entirety or not at all. These policies increased premium revenue relative to losses, improving the financial sustainability of the scheme, kept premiums lower, and reduced potential costs to the government.
Initial results looked promising. At the start of 1995, Pool Re announced that only 60% of premiums were required to be paid upfront with the remainder paid only if collective losses exceeded £50 million. After a loss-free year, the company raised that threshold to £75 million. However, the scheme was only as prosperous as the security situation allowed. The 1996 Docklands bombing in London’s redeveloped Canary Wharf interrupted this peace; it also breached the threshold for paying the full premium. In the end, Pool Re paid out £107 million in connection with this attack, one of the first large ones after Bishopsgate. Within a few months, that attack was followed by a bombing in Manchester that cost the Pool Re scheme £234 million.
The coverage provided by Pool Re was irreplaceable and increasingly well distributed. Whereas 225 insurers were members of Pool Re in 1994, more-or-less evenly split between Lloyd’s syndicates and other companies, some 260 were members by 2005. Each acted as an intermediary between customers and Pool Re and shared in part of the risk. Previous exclusions relating to chemical, biological, radiological, or nuclear attack have also been removed, broadening the coverage provided by Pool Re.
Today, Pool Re provides £2.2 trillion in coverage, has reserves of £6.6 billion, and has paid out £635 million in claims, all while contributing almost £1 billion to the British Treasury. Besides its retrocession agreement with the government, the company also makes use of private reinsurance. It has secured £2.3 billion in reinsurance from private firms and has even issued a £75 million terrorism-linked catastrophe bond to investors, an instrument which fills a role similar to reinsurance, albeit in bond form.
However, the market for terrorism coverage in Britain continues to rely on government support. This was not expected, at least if the reported intentions of the politicians who led the organization of the scheme are to be trusted. State involvement was supposedly meant to be only a temporary solution. Early critics of the program had argued that it would not be so temporary since Pool Re stood a large chance of crowding out private firms from offering similar coverage. Yet, at the same time, this is not the result of low premiums because some end users of Pool Re’s coverage have found the cover expensive and thus forgo purchasing it. While the optimal vehicle for providing terrorism insurance may be uncertain, the reliance of Britain’s terrorism insurance market on Pool Re is not.
Whatever its faults, Pool Re has allowed insurance buyers to maintain coverage against terrorism risk. That the government was called upon to support this market and intervened very quickly is testament not only to how dire the situation was in 1992-93, but also to the importance of insurance to the broader economy. Without terrorism coverage, property owners, their lenders, and their investors may have well have been ruined by the attacks such as those that plagued central London and other targets of terrorism through the years.
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1. “About Pool Re.” Pool Reinsurance Company LTD, 6 Apr. 2021, www.poolre.co.uk/about.
2. Atkins, Stephen A. “The Pool Re Scheme in the United Kingdom by Stephen A. Atkins.” The Future of Terrorism Risk Insurance, 2005, pp. 191–200.
3. Bice, William B. “Brittish Government Reinsurance and Acts of Terrorism: The Problems of Pool Re.” University of Pennsylvania Journal of International Law, vol. 15, no. 3, 1994, pp. 441–468.
4. Shillum, Roger. “Terrorism Insurance.” Property Management, vol. 15, no. 1, 1997, pp. 32–37.