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Can Insurance Cover Weapons of Mass Destruction?

Can Insurance Cover Weapons of Mass Destruction?. David Torregrosa Congressional Budget Office National Symposium on the Future of Terrorism Risk Insurance June 20, 2005

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Can Insurance Cover Weapons of Mass Destruction?

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  1. Can Insurance Cover Weapons of Mass Destruction? David Torregrosa Congressional Budget Office National Symposium on the Future of Terrorism Risk Insurance June 20, 2005 The views expressed in this presentation are those of the author and should not be interpreted as those of the Congressional Budget Office.

  2. Answers • In the short run, WMD risks appear to be uninsurable • In the long run, those risks should be insurable in the marketplace

  3. Policy Principles • Get incentives right by pricing risk • Let financial and insurance markets manage risks and promote mitigation

  4. Preserving Incentives • Insurance and capital markets provide pricing signals for managers • Avoiding potentially dangerous activities and construction • Protecting lives and property • Diversifying operations

  5. Investors Diversify • Insurance is not the only strategy for dealing with risk • Diversification among properties and locations • Shareholders and bondholders have diversified portfolios

  6. Little Private Coverage and Limited Federal Coverage for WMD Risks • TRIA leaves largely unanswered how WMD risks will be borne • Program coverage capped at $100 billion • Insurance and reinsurance generally exclude CBRN risks • No exclusions in workers’ comp

  7. Today, WMD Risks May Be Uninsurable • Terror threat likely to persist • Scale of the risk threatens solvency • Losses hard to estimate • Securitization not an option

  8. Will NBCR Risks Ever Be Insurable? • Capital markets have the capacity to assume large risks. • $100 billion loss would be about 0.5% swing in S&P Global 1200 • Market has made some progress pricing terrorism risks • Catastrophe bonds and contingent equity

  9. Other Conditions for Insurability • Insurers must add capacity • Reinsurers must enter market • Estimate must be improved • Disaggregating CBRN risks

  10. Regulatory Reform Options • Let cat bonds qualify as reinsurance and lower transaction costs • Precedent: accounting and regulatory reforms enabled the CMBS market to develop • Let insurers set aside tax-free catastrophe reserves • Deregulate at state level

  11. TRIA’s Effects • Increased availability • Lowered prices • But slowed adjustment of the economy to terrorism risks

  12. Policy Options • Let TRIA expire • Extend TRIA and expand WMD coverage but consider changes • Charge premiums • Raise coinsurance • Reduce government’s role over time

  13. Summary • TRIA leaves unclear how the federal government will respond to big WMD losses • Expanding TRIA to cover WMD fully may weaken incentives

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