Urban Catastrophe: A New Class of Risk

The following article, written for Global Reinsurance by Andrew Coburn, vice president of catastrophe research for RMS, was first published in January 2002.

Development of the WTC Loss

As the firemen and investigators slowly sift through the rubble of the World Trade Center, the analysts and claims managers have been picking their own way through the complexity of insurance claims that surround the events of 11 September. The true extent of the insured loss from the World Trade Center attack will take a long time to be finalised. Very many different lines of business were affected and many of the claims are expected to take years to finally settle.

By 9th of November 2001, 11,383 commercial claims and 7,476 personal claims related to the WTC attack have been logged by the New York State Insurance Department, at a notified value of $8.4 billion. These represent a small sample of the eventual claims total. Unlike a natural catastrophe, where the majority of claims are paid out within a year, some estimates expect that the long tail of the claims could run on for ten or twenty years.

Losses are now expected across more than 22 different categories of insurance business. These classes of insurance range from the property loss of the buildings damaged in the attack, to the compensation payments due under Workers' Compensation and other accidental death and dismemberment policies, through to various classes of business interruption and specialty contents lines. Each line of business is being explored and examined carefully to review contractual conditions, some already resulting in legal actions. The settlement for the loss of the two World Trade Center towers themselves will depend on the legal action currently underway between the insurers and the leaseholder. Liability issues are being examined in detail to determine the contractual obligations on such items as third party injury resulting from the building collapse. Business interruption claims are being received from locations all across the country and terms and conditions are under careful scrutiny to decide which are eligible for settlement. Some losses reserved for have now been recovered, such as the bullion recently retrieved from the rubble.

The variability of each of these components makes it difficult to estimate a final industry loss. Taking optimistic assumptions about each line of business, RMS estimates that the loss could stabilize at around $35 billion. However a more realistic estimate is that losses will eventually reach just over $50 billion. There are some less likely scenarios where class actions and other settlement decisions could result in the industry paying out tens of billions of dollars above that.

The biggest loss ever

By any analysis this is a loss bigger than any single event in insurance history. It is not, however, likely to be a magnitude that insurers have never contemplated. Many insurers and reinsurers manage their accumulations to between the 100 and 250 year earthquake and windstorm risk. The RMS view of the 100 and 250 year return period loss for the U.S. P&C industry is $53 and $69 billion respectively. By this measure, the WTC disaster, while not a natural catastrophe, will generate a level of loss consistent with the PMLs anticipated by most insurers and reinsurers. Consistent with this analysis, rating agencies believe that while some specific firms may be challenged, the industry as a whole will be able to handle the claims from the WTC event without significant disruption.

A new class of risk

Many insurers are now reacting to the World Trade Center loss by instigating far-reaching reviews of their business. These involve reviews of their terms and conditions, rating and covers, urban accumulation management, reinsurance purchasing and other portfolio management processes. The WTC loss signifies that a previously minor coverage has become a major loss potential – it constitutes virtually a new class of risk. Understanding this new class of risk, and how to manage it, is challenging many senior insurance professionals. Risk Management Solutions has been working with its insurance clients to review scenarios and approaches to managing complex urban risk following the WTC disaster.

The overall approach has been to review urban risk in a broader context than purely terrorist threats. It is important for insurers and reinsurers to learn from the WTC event about the correlation of different lines of business in a modern urban central business district, and to put into place measures that manage urban accumulations of risk. It is possible to ‘stress-test’ certain parts of the business through scenarios, and to examine how very different lines of business could suffer simultaneous and correlated losses.

Catastrophe risk beyond natural hazards

The WTC catastrophe raises several issues that challenge pre-existing measures of probable maximum loss:

	What is the range of events that should be considered in an assessment of catastrophe risk?
	Does the industry truly understand the extent of its urban accumulations of property exposure?
	Has the industry adequately understood the possibility of property, casualty and liability losses that may result from a single event?

For good reason, the insurance industry has focussed its catastrophe management activities on natural hazards. Since 1970, 38 of the top 40 most costly catastrophe losses have resulted from natural hazards. Natural catastrophe is the driver of catastrophe cost – RMS models suggest that the global P&C industry can expect an average of $20 billion in natural catastrophe losses per year, including the possibility for single event losses in excess of $100 billion.

However, as a man-made catastrophe, the WTC attack suggests that the industry needs to broaden its view beyond natural hazards. Even prior to 11 September, man-made events such as industrial accidents, aviation losses, large urban fires and explosion have contributed 20% of the total catastrophe losses over the past five years. Some of the worst man-made disasters in recent years such as the Exxon Valdez, Bhopal and Chernobyl could have cost the industry billions if they had occurred under plausibly different circumstances. Accidental explosions, such as the factory explosion in Toulouse in France 10 days after the WTC attack, have caused multi-billion dollar insured losses.