Canadian Underwriter

To buy or not to buy? When do companies choose terrorism insurance?

May 24, 2011   by Terri Goveia

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Why do some companies buy terrorism insurance and others opt against it? For the same reason that homeowners in flood or tornado-prone areas eschew coverage, according to a University of Pennsylvania study that found that corporate risk managers and average homeowners aren’t so different in the face of risk.

Many companies don’t have terrorism insurance–those that do are willing to pay more for it, and those that don’t often have an “it won’t happen to me” attitude, researchers at the Wharton Risk Center found. Their study compared how risk managers view terrorism and regular property–catastrophe vs. non-catastrophe-risks–noting that “how individuals perceive the risk is likely to be a much more important factor influencing decisions than estimates of the risk provided by experts.”

Were they right? Companies that don’t buy terrorism insurance often exhibit some of the same “over-optimism” that homeowners do when making decisions on coverage. They either decide to self-insure, or they don’t believe another terrorist attack will affect their operations, says Erwann Michel-Kerjan, managing director of the Wharton Risk Center at the University of Pennsylvania.

“We had the first terrorist attacks in 1993 on the World Trade Center, and then again in 2001,” he says. “Some companies think it’s over.”

The researchers also found that large companies have lower coverage than their smaller counterparts–probably because the rely on their own risk management teams, he says.

And those corporations  that chose to buy it were willing to pay more for it–a 10% price increase had little effect on demand, the researchers found. Facing higher prices, the demand only dropped by 2.42%, compared to those buying property insurance, where a similar price hike decreased demand by 2.93%.

The study–the first to compare corporate catastrophic risk decisions against regular risks–used Marsh & McLennan data on 1,800 U.S. corporations.

Weighing risk

Risk managers who did buy terrorism coverage tended to be more risk-averse, and may even consider the career risks of not buying coverage, the study determined.

For a homeowner making a insurance purchase decision, “the trade off is [either] buying that coverage and buying a plasma TV. When you make a decision on behalf of the company, you have less pressure on spending that money,” Michel-Kerjan says. “People say, it’s not my money, I want to protect the company, the risk is probably small, but let’s buy that.”

And immediate catastrophes tend to make the risks real for corporations, he says. After terrorist attacks on Spain and London in the mid-2000s,  “many American companies looked at their portfolios, and said, ‘we thought it was over,'” he says.  “That’s the difficulty with terrorism, you can have 25 attempts stopped by intelligence and no-one knows about them. With terrorism, the historical data is limited.”

The findings can help the industry consider several questions–including pricing of terrorism insurance and corporate demand says Michel-Kerjan. Industry stakeholders could use it to gauge awareness among senior executives–“are they aware they’re not covered?”  he notes–and examining whether insurers are charging enough for the coverage.

“The price of terrorsm coverage is going down and down and down,” he points out. “My  question to the insurance companies, is are you ready for another attack? Are we charging enough premium to be even here?”

This story was originally published by Canadian Insurance Top Broker.