The events of Sept. 11, 2001, changed the way the United States viewed the security of its borders and its approach to terrorism. The insurance industry, which lost many of its own in the destruction of the twin towers in New York City that day, also changed. Without a federal backstop in place, insurance rates would have been out of reach for many businesses with terrorism exposures. Jack Seaquist, vp at AIR Worldwide, oversees the Boston-based catastrophe modeling firm's terrorism risk model and offers his thoughts on stabilizing an ever-evolving threat.

Since the tragic events of Sept. 11, 2001, anti-terrorism efforts by local, state and national agencies have combined with evolving political situations overseas, making the terrorism threat in the United States highly dynamic.

Groups that pose the threat, the types of weapons used, and the targets and locations of potential attacks change over time as new methods are developed and new situations arise.

Al-Qaida's core group has suffered from pressure on its leadership, highlighted by the May elimination of Osama bin Laden and other top leaders. This has degraded their capabilities to plan and conduct operations against Western countries. Their role has been reduced to inspirational leadership, significantly reducing the likelihood of a large-scale, coordinated attack in the United States. However, the group continues to draw up plans for operations on U.S. soil.

While counterterrorism actions have crippled al-Qaida's efforts to coordinate a sophisticated chemical, biological, radiological or nuclear attack, the U.S. intelligence community suspects that the group still is looking to acquire this capability. In the wake of the 1995 sarin attack on the Tokyo subway and the 2001 anthrax attacks in the United States, the potential for CBRN weapons to cause widespread casualties and contaminate infrastructure over a large area remains a threat.

Meanwhile, al-Qaida affiliates have eclipsed the core command as the most imminent threat. In Yemen, al-Qaida in the Arabian Peninsula has inspired and/or organized attacks against the U.S. in recent years. These include the November 2009 Fort Hood shooting, the Christmas Day 2009 airline bombing attempt and the October 2010 printer cartridge bomb in a cargo airplane. Although not al-Qaida in the Arabian Peninsula, the 2004 bombing of Madrid's subway system as well as the 2005 bombing of London's public transport system were also linked to al-Qaida.

AQAP now is heavily targeted by U.S. forces, but the group continues to call for domestic terrorist aspirants to conduct attacks in their home country using techniques espoused on the Internet. They discourage these potential terrorists from traveling to obtain training and weapons, and instead encourage the use of simpler weapons. From a catastrophe loss perspective, this reduces the resulting threat to events of lower intensity.

Recent political upheaval known as the “Arab spring” uprisings in countries such as Tunisia, Egypt, Libya, Yemen, Bahrain, Saudi Arabia and Syria have the potential for both positive and negative effects on the terrorist threat in the U.S. In the near term, these situations are more likely to cause increased civil unrest in those nations rather than a more formidable front of terrorist activity. At the same time, a vacuum of leadership could allow terrorist groups to establish new bases and attract new recruits.

Perhaps of greatest concern is the impact of the highly symbolic death of Mr. bin Laden, which has disrupted al-Qaida's core group. Jihadists have vowed vengeance and most experts agree that they aspire to a large-scale attack.

In anticipation of this, the U.S. government has enhanced its intelligence efforts. Nevertheless, the possibility of an increase in attacks, particularly by lone terrorists, remains a real concern.

The impact of Sept. 11, 2001, on the insurance industry was immediate. Once covered in most standard all-risk commercial policies, reinsurers either refused to renew terrorism coverage or began charging exorbitant rates. Unable to purchase reinsurance or to otherwise raise sufficient capital, insurers adopted new policy forms with terrorism exclusions. For a time, terrorism coverage was virtually nonexistent.

The U.S. government responded by passing the Terrorism Risk Insurance Act in November 2002, in part to help stabilize the market. TRIA, along with its renewals in 2005 and 2007, established the Terrorism Risk Insurance Program. For most commercial lines, the program provides government-furnished reinsurance for direct terrorism losses above the insurance company's deductible, subject to a copayment by the insurer.

The Terrorism Risk Insurance Program Reauthorization Act, which was passed in late 2007, extended the federal terrorism insurance program for seven years through 2014. This gave insurers the sense of stability needed for a viable market. Coverage of conventional terrorism has been made available at prices sufficiently reasonable for takeup rates to have grown and stabilized, particularly in areas perceived to be at high risk.

However, coverage for CBRN attacks has remained scant because insurers are unwilling to offer it—at least at prices policyholders can afford—given the potential magnitude of the losses. By AIR Worldwide estimate, a single CBRN event in New York could exceed $750 billion in insured losses, which would surpass the combined surplus of the U.S. property/casualty industry.

In the months following the attacks of 2001, considerable discussion took place on how best to prepare for and mitigate future losses from terrorist attacks. What were the chances of another attack? How frequently might such attacks occur, and how severe could they be in terms of insured loss?

Insurance markets function well when losses are relatively frequent, relatively small, uncorrelated and random. Catastrophe losses meet few of these criteria: they are large, infrequent and highly correlated. With respect to natural disasters, catastrophe modelers have in large degree overcome the obstacles to estimating future losses. Estimating losses from terrorist attacks, however, presents a much greater challenge.

Historical data on terrorist attacks is much more limited and may not be representative of the current threat. Even more importantly, while scientists and engineers can achieve mastery over the physical science underlying natural catastrophes and their impact on the built environment, terrorist activity resists scientific quantification. In addition, while natural catastrophe risk remains relatively stationary over time, terrorist threat is highly dynamic.

One year after the attacks of Sept. 11, 2001, and at the request of its clients, AIR released the first commercially available catastrophe loss estimation model for terrorism. The model estimates the likelihood of future terrorist attacks and their impact in insured property and workers compensation losses.

Where natural catastrophe models are constructed based on decades of historical data, AIR's terrorism model incorporates the judgment of a team of experts—a “red team”—familiar both with the available historical data and current trends. The red team is comprised of counterterrorism specialists who have decades of experience in government organizations such as the FBI, CIA, Department of Defense and the Department of Energy. With input from the team, AIR has developed a comprehensive database of potential targets, or landmarks, across the United States, which include many of the same buildings found in the Department of Homeland Security database and a subset of “trophy targets” that carry a higher probability of attack.

In an analysis of 32 terrorism cases against the U.S. homeland since Sept. 11, 2001, approximately 60% of the cases involved explosives and another 30% involved small arms. Of all target types, government and transportation were the most prevalent. Over the past 10 years, the relative frequencies of different weapons usage, target types and locations as determined by AIR's red team have been in good agreement with actual experience, validating the model's methodology. Fortunately, many of the actual plots were thwarted.

The future of the federal backstop for terrorism coverage is set to expire in 2014 as the administration considers limiting its exposure as part of deficit-reduction efforts. While the current appetite for terrorism coverage is healthy, many insurers have begun to make longer-term plans for terrorism risk management in the absence of the TRIP.

Sophisticated modeling tools will continue to play an increasingly important role in helping companies evaluate and manage their terrorism risk by enabling better risk selection and risk transfer decisions.

Jack Seaquist is an assistant vp at AIR Worldwide overseeing the Boston-based catastrophe modeling firm's terrorism risk model. He can be reached at jseaquist@air-worldwide.com.