S&P weighs insurer terrorism risks

Terrorism risk affects different insurers in different ways, according to a report issued by Standard & Poor's Ratings Services Wednesday.

The report—“Ten Years Later, Terrorism Exposure Remains an Issue for U.S. Insurance Companies”—says insurers need to estimate coverage and risk mitigation for terrorist attacks differently than losses from natural catastrophes because terrorist attacks are not predictable in the way that some natural catastrophes are.

“The risk of a wider economic impact is also a consideration,” said New York-based S&P.

The report says that another terrorist attack on U.S. soil, other than a nuclear attack, would have a significant impact on only a few insurers. S&P said the risk of insolvency is greater for insurers with “indirect exposure through a high percentage of commercial property and workers compensation business in metropolitan zones.”

The report said that given the high-severity, low-frequency nature of terrorist attacks, “we believe a man-made catastrophe would be a capital event rather than an earnings event—meaning we would expect an affected company to lose more than one year's earnings due to a sizable terrorism event.”

S&P said an insurer's loss of more than a year's earnings—translated into a capital erosion of more than 10%—or terrorism losses outside the insurer's stated risk tolerance that would make it appear to be an outlier relative to peer companies, “would likely” cause S&P to take a negative rating action on the company.

S&P notes that even though the federal terrorism insurance backstop program provides coverage for insurers that participate in the program, a loss within a given insurer's deductible could amount to more than one year's earnings.

The report also said that a terrorist attack's economic impact might not be confined to the site of the attack, but could instead present a “contagion factor on the macroeconomic level.” That could include weaker economic conditions and a drop in investment valuations affecting the adequacy of reserve and investment income.