New AIR Estimation Model Helps Insurers Price Terrorism Risk

In an effort to help property/casualty carriers racing to price and offer terrorism coverage after the passage of the Terrorism Risk Insurance Act, AIR Worldwide Corporation has introduced a new estimation model, the Terrorism Loss Estimation Model.

AIR’s new probabilistic model provides estimates for both property and workers’ compensation losses a given company would face in the event of a future terrorist attack, and a wide range of potential terrorist threats is accounted for by the model. Considerable arrays of terrorist organizations, weapons, and more than 300,000 potential targets are incorporated into the new tool.

AIR project manager Jack Seaquist explained the development process, noting, “We were trying to do a loss estimation model, a catastrophe risk analysis like we’ve done for hurricanes and earthquakes, that can be used by insurance companies to set prices, to manage their risk in terms of reserves and reinsurance and to help in reinsurance pricing,” he said. “In general, for everyone to understand the potential risk of losses. It needs to be a comprehensive model to look at all the possible things that could happen, and have them appropriately weighted.”

Without attempting to predict frequency, the model provides estimates of both frequency and distribution of possible attacks. “We’re estimating frequency based on expert opinion, which has two components—the frequency of attacks, but more importantly, the distribution of them,” Seaquist said.

“We use people that are in the counter-terrorism threat assessment business—the FBI, the CIA, the Department of Defense, the Department of Energy,” he continued. “So we rely on their collective experience, 100 years’ counter-terrorism experience, to help us estimate what might happen in the future. We use a structured process to collect that expert opinion using something called the Delphi method to combine the opinions of multiple experts. It’s a process for keeping the experts on their own track yet still providing feedback in an anonymous way.”

The model consists of three major components: probabilistic loss analysis, exposure concentration analysis, and deterministic loss analysis.

Probabilistic loss analysis involves estimates of both frequency and severity to determine average annual losses by policy and probability distributions. Exposure concentration analysis consists of using geocoding and mapping to display and analyze an insurer’s concentration of risk. Using a database of more than 300,000 structures, AIR can calculate and map a company’s concentration of exposures near possible future attack sites. Finally, deterministic loss analysis includes weapons effects modules used to estimate losses for specific potential scenarios provided by users of the tool. “The types of attacks we’re looking at are conventional-bomb blasts, air crashes—and then the CBRNs—chemical, biological, radiological, and nuclear. Those might otherwise be called weapons of mass destruction,” Seaquist explained.

The AIR model has some advantages for individual carriers over loss costs provided by AIR’s parent, ISO, Seaquist said. Since ISO loss costs are based on industry averages, they do not necessarily represent the exposures facing an individual insurer. AIR terrorism risk analyses have the ability to indicate areas in which ISO loss costs can be used, as well as areas where an insurer’s risk is greater than the industry average, and requires different pricing.

Topics Catastrophe Natural Disasters Carriers Profit Loss