Time for a Global Legal Scheme for Terrorism Risk Insurance

Aloke Chakravarty*

Daily headlines remind us that international terrorism is a global risk, and it will continue to be one for the foreseeable future.  The financial impacts of terrorist attacks have steadily increased over time.[1] In property claims alone, the twenty most costly attacks, most of which have occurred over the past twenty years, have cost more than thirty billion dollars in claims, and with life, health, and liability claims, the total cost could be trebled, or more.[2] It was therefore unsurprising that since the attacks of September 11, 2001, companies have sought private commercial terrorism insurance to mitigate financial risk created by terrorist attacks.[3]  These companies have recognized the new normal of our times: that terrorism is a foreseeable threat in our society and can exact a brutal economic—as well as human—cost. In 2001, the perpetrators intended to strike a financial capital in part because of the ripple effect that the attack would have in our society. The impact was felt beyond the financial system of one community; because of the interconnectedness of international finance and commerce, the secondary effects were felt across the world. Terrorists celebrated their success for years afterward, and still champion such spectacular attacks to suit their ends. But that is not the only evolution of the threat.

In part because of the growth of the internet and geopolitical environment, we now face the advent of retail, domestic recruitment. Terrorist groups are advocating more frequent, simpler, and less coordinated attacks, and are trying to recruit people in our own neighborhoods. They call for the types of attacks that will be less detectable and easier to carry out, and they have provided instructions on how to do just that. Additional risks are increasingly foreseeable—State sponsors and multinationals are actively exploring cyber-intrusions; others have deployed their chemical stockpile; and the Ebola epidemic has shown the impact and feasibility of a biological agent.  In countries that thrive on free markets and open societies, the risk of terrorism challenges the complicated relationships between businesses, government, and the communities in which we live.

In the commercial world, one of the ways to establish some measure of security is to obtain insurance or an indemnification policy. Even families feel marginally more secure when they have acquired insurance to protect their loved ones. Still, there were very few options for terrorism risk insurance until recently. Fifteen years ago there was virtually no private market for terrorism insurance. Despite a demand, this type of insurance was not an appealing product for insurers because of the complexity of the space and the exceedingly limited data on all of the variables that were needed to create algorithms to value risk. Specifically, the risk modeling that underwriters do to analyze the probability, scope, and impact of an attack, coupled with the need for data on terrorist targeting and capability, made it a tenuous financial proposition.  This was more the case when considering the additional challenge of pegging the right premium amounts to be sufficiently capitalized for a payout, and that a claim amount could be catastrophic and lead to ruin for an insurer. In essence, it was too risky.

At the same time, governments considered the costs of terrorism through at least two lenses. The first was to soften the societal cost of lives and property destroyed because of a terrorist attack. Governments often establish victim compensation funds or otherwise provide disaster relief following attacks. Another approach considered was whether anything could be done to mitigate the risk of attacks, and to mitigate the impact of the attacks that do occur. Governments began to link the risks versus impacts of an attack in a security strategy, just as the terrorists who planned them had been doing for years.

After September 11, 2001, these sentiments drove a push for a terrorism risk insurance market.[4] The developed world created systems for underwriting terrorism risk—typically these systems addressed the risks to their private commercial interests.[5] Several developed countries, have encouraged private insurance markets, offered express nationalization of risk, or created hybrid models where public assistance and private insurance along with basic altruism fill the void.[6] However, since terrorism was a novel challenge for insurers and they still did not have the data they required for cost-effective and widely available products, insurers did not respond. A few developed nations recognized, however, that establishing a widely-available insurance system was largely preferable than going without, both to the government’s interests as well as to the interests of putative victims.[7] The benefits of intervening in the private market outweighed the cost of such intervention.[8] They recognized terrorism risk as a private and public issue. In turn, in 2002, the United States passed a law mandating the creation of a temporary terrorism risk insurance market through the Terrorism Risk Insurance Act of 2002 (“TRIA”).[9] Many countries helped broker some form of national terrorism insurance, and the lessons in this evolution suggest that an international response is better coordinated early rather than after the existing regimes become established and entrenched.

The solutions have been far from perfect. The process of offering private terrorism risk insurance, with a component of governmental underwriting, has been inefficient, inconsistent and parochial; often counting on government largesse to accept risks that private insurers will not. Quantifying the risk involves the accounting of myriad complexities starting with an endless number of potential targets, the method of attack, weapons used, geography, and the list goes on. The inherent difficulty of establishing reliable models of impact amidst what is arguably an unpredictable environment has hampered the propagation of terrorism risk insurance policies, particularly among multinational corporations and across international legal systems.[10]  This variation, as well as cumulative coverage under other policies, has led some to question the utility of terrorism risk policies altogether. Existing policies not only have extensive exclusion provisions but, more fundamentally, they are not part of a self-sustaining market for the types of policies that will holistically address insurer, insured, and governmental concerns.[11]

Still more, the national regimes that have emerged are subject to varying legal systems and philosophies of indemnification. These systems do little to accommodate for the shrinking world, the interconnectedness of catastrophic incidents on financial systems, global infrastructure, geo-political interests, and even more direct impact from incidents that cross borders, such as cyber-terrorism.[12] An international regime, involving private underwriters and reinsurers, collaborating with participating governments and international institutions, would go a long way to building in predictability—the essential currency of risk-mitigation. Some call such a specialized system an illusion or even a security theatre.[13] This calculus has impeded innovation in the terrorism risk insurance field over the past decade. The current system is stagnant and has not evolved with the nature of the risk that it is designed to protect against.  Moreover, the U.S. Congress has allowed the TRIA to lapse in 2014, at least temporarily, signaling either private sustainability in the industry, or more realistically, an unreliable long-term infrastructure for managing financial risks associated with terrorist and cyber-attack threats.

This article promotes an international diversification of the financial costs associated with terrorism risk and encourages the drafting of a multi-lateral treaty between member states and existing international institutions, which calls for (a) the creation of domestic terrorism insurance markets pegged to international standards; (b) the provision of capital to an international terrorism fund; and (c) a system of information-sharing and analysis of often-opaque information concerning terrorist events from member states in order to stimulate private sector risk analysis.

I.      The Value Propositions of an International Scheme

Global Development. According to data published by the U.S. State Department, in 2013 there were at least 9,707 incidents involving terrorism, most of which occurred in the developing world.[14] The volume and nature of these attacks are consistent with the trend over the past two decades. The countries in which many of these attacks occur have less-developed economies and legal infrastructure and fewer financial services firms that can insure against losses from such attacks. Yet, they are all hungry for foreign investment and infrastructure development. Some of these countries, such as Iraq, Syria, and Afghanistan are flirting with becoming failed states, with unstable governments and immature risk markets. Still others, like Nigeria and India, have robust and well-developed economies that struggle with corruption and have unwieldy domestic legal frameworks upon which multinationals are reluctant to rely. All of these states offer new markets and development opportunities for multinational corporations.  Terrorism risk insurance could offset the higher risk of infrastructure investment in these places, and the benefits abound for both the origin country and the multinational. Stated this way, the value proposition of an international framework for providing insurance coverage in these places is plain for commercial interests, and economic benefits of the multinational’s expansion abound for both the multinational’s home and target economy. Companies are more likely to explore ventures with financial and human capital risk if they know that the financial costs are likely to be mitigated.[15]

A corollary of this moral hazard investment may itself reduce the risk of terrorism:  populations affected by terrorist activities are more likely to align with those who help them rebuild rather than those who cause them harm. From a policy perspective, creating incentives for international terrorism insurance benefits developed economies by energizing their corporations through risk mitigation, buffering financial volatility, and lessening destabilizing impact on those countries that are most vulnerable to unmitigated costs of terror. Similarly, since preparation for rare, catastrophic losses requires a large amount of reserve capital, policies should encourage creative, but secure investment use of such capital, which is easier to do in a pooled or diversified manner.[16] Equitable accounting and tax treatment of these capital reserves is critical and provides assurance that highly capitalized insurers do not become ripe for takeover bids when outstanding policies expire.[17] International legal principles support the creation of a private-insurer friendly scheme that provides a common language, international norms of accessibility and valuation, and caps and disbursement mechanisms for participating states.

International Law.  International law supports the implementation of government-supported private insurance solutions to the problem of insuring property and casualty losses stemming from terrorism. International legal principles have long supported the global mitigation of terrorism risk, and the United Nations (“U.N.”) has called for such a goal.[18] As with other security cooperation agreements, the creation of an international terrorism insurance scheme reinforces the customary international law norms that international terrorist acts are universally condemned by civilized nations.[19] International terrorism violates Article 39 of the U.N. Charter because, by virtually any definition, it disrupts international peace and security. While most international law related to terrorism takes the form of conventions and treaties designed to encourage cooperation in terrorism investigations, the common thread woven through this jurisprudence is the condemnation of terrorism and the principle among nations to allow justice to be sought for the victims.[20] For example, the U.N. Declaration on Measures to Eliminate International Terrorism (1994) noted that due to an increase in acts of terror, member states should “review urgently the scope of existing international legal provisions on the prevention, repression and elimination of terrorism in all its forms and manifestations, with the aim of ensuring that there is a comprehensive legal framework covering all aspects of this matter.”[21] Whether prohibitions against international terrorism have evolved into jus cogens remains to be seen, but there can be little question that it has evolved, at least in part, into customary international law. Collective attempts to deter international terrorism, or to ameliorate its effects, are expected of civilized nations.

Terrorism indemnification is not just a commercial law issue; it is one of international human rights. The U.N. Global Counter-Terrorism Strategy includes the consideration of victims’ rights as a component of a comprehensive system to degrade the conditions in which terrorism can take root.[22] Because victim compensation resonates as an access-to-justice concept, existing international law supports the propagation of terrorism risk insurance as a customary prophylaxis to reparations.[23] Over the past twenty years, state practice has attempted to ameliorate the impact of international terrorism upon victims, and therefore such practice is integral to a global insurance scheme. The costs of international terrorism routinely impact more than private companies, but rather entire populations, often as a result of targeting based on membership in a particular social group. The principles of international human rights law similarly contemplate a shared international willingness to intervene with prophylactic and restorative justice measures, such as an insurance scheme, as necessary, to address human rights abuses like terrorism.[24]

International human rights law has also evolved to recognize crime victims’ rights, including some measure of financial satisfaction for damages resulting from grave and serious violations of international law.[25]  As Bassiouni observes, the Declaration of Basic Principles of Justice for Victims of Crime and Abuse of Power (1985), and the Basic Principles and Guidelines on the Right to a Remedy and Reparation for Victims of Gross Violations of International Human Rights Law and Serious Violations of International Humanitarian Law (2006) have memorialized the U.N.’s commitment to a bill of rights for victims of such violations of international law.[26]  Because acts of terrorism often constitute gross violations of human rights, it stands to reason that an international scheme that aspires to make victims of such violations whole through private or public insurance, complements the development of international law and provides quasi-private solutions to customary international law principles. That customary international law supports insurance among nations against gross violations of international law can be seen in the growing recognition of crime victims’ rights to representation in international law; a fact that makes their interests, including interests of reparation, or restitution, more prosecutable.[27] The International Criminal Court now expressly affords crime victims representation in criminal proceedings and budgets for victim and community services related to the crimes it investigates.[28] Similarly, the ad hoc tribunals, the International Criminal Tribunal for the former Yugoslavia, the International Criminal Tribunal for Rwanda, Extraordinary Chambers within the Courts of Cambodia, and the Special Tribunal for Lebanon, which was designed to address an act of terrorism, each have arms dedicated to victims services through which victims can access justice before an international tribunal.

International economic and commercial law would also benefit from a standing arbitration system in adjudicating indemnification and coverage determinations across countries.  Private companies doing business globally, and their insurers, often wrestle with choice-of-law provisions as they attempt to create opportunities around the world. Impediments include unpredictable outcomes, or worse, unenforceable judgments involving countries with less developed legal systems, and for litigants who wish to perfect claims. Both ad hoc and institutional arbitration exacerbate risks of securing judgments, receiving insurance or re-insurance payouts, and otherwise enforcing contractual obligations. An agreed-upon arbitral system and principles of adjudication would dramatically benefit global insurers and those they cover, eliminating some of the unpredictability and politicization that comes from the sui generis nature of assessing terrorism judgments.

Diversification of Risk.  Diversifying some of the financial risks associated with terrorism provides benefits across economic strata. The costs to those who can afford it are modest, and the benefits to those who need it are profound. Sharing a financial stake in deterring acts of terror fundamentally aligns nations and their populations. Even a modest step toward tangibly connecting peoples’ fates can have a dramatic impact in the context of the oppositional framework of terrorism ideology and the use of propaganda to mobilize policy grievances. More pragmatic benefits also follow from sharing at least some collective exposure. Currently, jurisdictional and choice-of-law issues often foreclose or politicize private international litigation in domestic courts. For the developed world, providing a predictable payment scheme can encourage private companies to do business in higher risk areas; can help stabilize relations with the most vulnerable states; and can quantify and limit the potential financial exposure from a terrorist incident abroad. At home, the competitive advantage of subsidization will encourage or require private insurers to enter the market with more innovative products and pooling agreements. The limits on exposure can provide a buffer from a dramatic economic shock. Quantifying risk will be more accurate as a result of deeper valuation and analysis of the integrated nature of critical infrastructure systems, which should also yield smarter security investment.[29] For developing countries, the direct relief after a terrorist attack, as well as the economic growth stimulated by outside investment and infrastructure, in addition to a more predictable and reliable indemnification system, could provide buffering economic growth as well as civic development.

International Capitalization.  The establishment of an international terrorism capital fund could be an important component to an international insurance scheme. The Basel Accords III demonstrated the feasibility of international capitalization norms in response to the global financial crisis.[30]  Recognizing this need, the capital reserve fund proposed the Terrorism Risk Insurance Modernization Act as part of the now lapsed TRIA reauthorization bill. If the proposal were to be adopted into the bill, it would provide insurers with greater liquidity, and also permit investment of the fund in acceptable instruments. Given the lessons of the global financial crisis that began in 2007, the need to have fully capitalized insurers and reinsurers has become even more prominent, despite the rarity of a catastrophic event. Whether public subsidies are through direct governmental insurance, or through re-insurance type arrangements, a macro-pool of capital provides various benefits to a global insurance system. First, the fund could help buffer the risk of ruin to private insurers, reinsurers and vulnerable governments from an act of terror. Second, governments and their populations will tend to be more vested in the stewardship of a fund in which they have sacrificed treasure to participate.[31] Third, a common fund can mitigate hegemony by providing worldwide access to insurance that is derived from egalitarian principles of public international law. Fourth, a common fund can help member states share the financial interests in the fate of others who may be targeted by terrorism.[32] The fund may be most responsibly reserved for insurance, but could possibly be repurposed as member states agree, or as private insurers offer their own unsubsidized products. As in the case of direct foreign aid, provision of financial security by the world community could extend goodwill and access to the populations with grievances that sometimes motivate terror. Moreover, all of these benefits accrue regardless of where future terrorist attacks occur among the signatory nations.

Information Sharing.  One of the most substantial challenges to private markets for terrorism insurance is the absence of transparent and reliable information regarding incidents of terrorism and the nature of the terrorist threats, as well as the assets they target.[33] In 1997, when the U.N. supplemented its Declaration on Measures to Eliminate Terrorism, it specifically encouraged more robust sharing of timely and accurate information.[34] An international terrorism insurance scheme must better share (a) information about threat-assessments and trends; (b) analysis of private sector critical infrastructure valuations; and (c) information about terrorism incidents, including attempted and thwarted plots, to better quantify risks. To the extent that information is collected and analyzed by nation-states and security organizations, it is often done confidentially and only shared confidentially with partner security components. The restraints on access to actual data of the type that may substantively affect terrorism-risk modeling and premium calculations leads to a further impediment to an international market and accurate prioritization of a state’s security resources. Therefore, providing a mechanism for information sharing between states and insurers, even derivative and post-analysis information, highlights the public-private partnership, which may encourage greater collaboration in valuations and yield more accurate coefficients in modeling. In return, the robust tools in the private sector used to model risks to infrastructure, predicting collateral impacts, valuing business or industry interruption and other factors used to price other risk markets, could be shared with governments and NGOs to craft security measures and prioritize policies. This two-way information exchange around costs, values, and predictability will undoubtedly serve to create better modeling of risk, with the collateral benefits of better prioritization of assets, security policy, and mitigation strategies.

Public-Private Partnerships.  The subsidized insurer model provides government backing to private industry. One of the most common forms of government stimulation of inadequate private markets is to create tax incentives, or to permit securitization of risk or a fund that can derivatively trade on an exchange.[35] This arrangement—a version of which is the centerpiece of the insurance markets in countries such as the United States, United Kingdom, and Israel—encourages private insurers to provide terrorism insurance at rates comparable to the rates attendant to other risks for which economic modeling is more robust. There are a variety of permutations to this arrangement, some of which provide outright capital inflows; some assure government outlays for a percentage of loss, typically up to a cap; and others stimulate the market by further subsidizing a reinsurance market. As proven by their necessity, given the potential of catastrophic risk resulting from terrorism events and the limited predictability, private insurers have relied on these government stimuli to offer such insurance. Many of these subsidized arrangements were designed to be stopgap transitional measures, which would give way to adequate data for fair business-oriented pricing models. However, with the reliance on government intervention and an absence of incentives to shift away from the dole, insurers have been quite content to continue business as usual.

International involvement can also subdue the hegemonic forces that drive the market.  While some entities will be able to create customized terrorism risk insurance plans with private insurers, they will do so at the cost of creating bright lines for those who can have insurance and those who cannot.[36] The hardening of one target to the exception of another does not reduce the overall risk of terrorism events, since all things considered equal, terrorists may simply select the easier target.  In this way, as with many others, the terrorism risk insurance paradigm can be compared with the health insurance model promulgated recently in the United States. The costs for the entire program are disproportionately borne by a few, but the existence of the program is designed to reduce the costs overall and provide broader access.

II.    Administrative Challenges of an International Scheme

Some of the challenges of terrorism insurance are better suited to uniform interpretation in an international convention than to varied state practice.

Definitions.  There is a wide spectrum of definitions across the various insurance models.  Defining the triggering event is itself varied, and not necessarily consonant with domestic or international humanitarian and human rights laws. An international scheme can provide international norms and a common standard for many of these definitions, further ensuring predictability in the case of a loss.[37] Moreover, subjective assessments of these requirements, especially to the evolving concepts of property and infrastructure, could extend to such activities as cyber-intrusion with imputed intent, resulting in judgments that extend across international borders to subject other nation-states or multinational organizations to liability. The use of a common lexicon and triggering criteria can itself be one objective of an international scheme.

Triggering Events.  What types of acts are to be covered by the convention will be the product of some debate, but there is likely much that member states can agree upon. In fact, the triggers can be narrow when other hazard coverage typically covers claims.[38] What constitutes acts of international terrorism, particularly those acts born of ideology that crosses borders, is more easily agreed upon than acts resulting from strictly separatist movements or acts that are isolated to one or two countries.[39] Some types of acts, which often have terrorism motives, have also been recognized as particularly egregious in customary international law and by treaty.[40]  For example, under the TRIA and other domestic subsidization regimes, for liability to apply, a triggering event must occur whereby a senior government official, such as a minister of justice or treasury, must certify that the event constitutes the preconditions of the insurance regime.[41] It may be best to make the heads of the agencies most integral to the disbursement of funds—for example, perhaps the head of the IMF or OECD, the Secretary General of the U.N., or some other relevant entity—responsible for the certification.

Choice of Law.  One of the first challenges of a terrorism insurance convention will be to decide how to normalize the wide variation among reliability of legal and administrative structures across countries. The synergies of using established legal principles within a dedicated tribunal, such as the International Tribunal for the Law of the Sea, or for specific international legal principles being applied in a court that relies on them, provide much greater uniformity of justice than in ad hoc legal rulings in various legal systems across the world. For example, instead of wondering whether the loss of an oilrig in South Sudan will be adjudicated in the fledgling Sudanese judicial system, multinationals that provide foreign direct investment can be assured of a judicial infrastructure to render a judgment, and can budget risks accordingly. The utility of an arbitral tribunal for insurance issues need not be confined to international terrorism insurance conflicts, but a system of creating a universal lexicon for global subrogation must begin somewhere.  Creating such a widely used commercial system will also strengthen international law, since current subrogation practices are often limited to the ability of a court to enforce a judgment. Even if a new tribunal is too bold of a step, simply adopting some common international legal principles and vocabulary into existing national systems could be an important innovation which will help prevent the type of insurance hegemony among states that exists within states.

Scope of Coverage.  The scope of a typical coverage policy is another area with substantial variation with regard to domestic practice. While various policies can be customized, individual states currently carve out exceptions to the minimal requirements of coverage in government influenced systems. In some cases, these exceptions subsume the coverage.

Pricing.  Across countries, insurance companies have priced premiums without horizontal integration for similar risks in other countries. In 2009, for example, the median rate of coverage in the United States was approximately .0025 percent of total insured value, while the same premium for insuring certain infrastructure in Spain was up to .195 percent of insured value.[42] This kind of variation suggests that the risks or costs in Spain of a terrorist attack are almost one thousand times greater than in the United States. A review of incidents on the Global Terrorism Database for 2009, however, shows that Spain had twenty-one incidents, and the United States had ten.[43] An inefficient pricing model adds to the disincentives for insurers to enter this space, as well as to customers who may remain concerned about the value of a type of insurance for which they have gone generations without purchasing.

III.   Global Terrorism Insurance Prepares for and Mitigates the Risk of Terrorism

The role of terrorism risk insurance as a tool for terrorism risk mitigation, has been underdeveloped in the literature and merits some discussion.[44] Terrorism is an act of ideology, and those actors are often not rational in the conventional sense. However, there is a longer-term economic rationale for much of the international terrorism that we face, and some of the actors are specifically considerate of the economic impact of their actions. Together, these observations suggest that an economic strategy to mitigate the impact of terrorism will itself mitigate the value proposition for terrorists. Moreover, the diversification and absorption of the costs of terrorism to a broader, multi-national populace, including especially those from the places from where terrorists attack, can serve to counter the narratives and diminish the political capacity for terrorists to embark on their operations. By degrading popular support, diversifying and indemnifying the impact of their actions, and by having their host governments and populations pay the costs of their activities, rational actors will find alternative, less destructive avenues to pursue.

In addition, if terrorists are rational economic actors, some theorize that they can be deterred from some targets in favor of others because self-protection measures, such as insurance, minimize the benefits that a terrorist can expect to obtain.[45] In an attempt to inflict pain upon opposing regimes beyond their people and infrastructure, terrorists have frequently turned to attacks on financial targets.[46] One of the purposes of attacking targets that create large economic losses is to maximize the impact of their attacks on the terrorists’ enemies, as well as theoretically to degrade their abilities to continue to attack the terrorists’ affinity group. State-sponsored attacks are particularly vulnerable to this rationale—assuming the evidence exists to tie a state to an act, say a cyber-intrusion or sabotage, a state faces not only political backlash, but also the prospect of increasing insurance costs among other states. Diversifying risk among nations creates counterincentives for terrorists to attack the interests of their benefactors. Moreover, to the extent that terrorists are not rational economic actors and attack anyway, they are more likely to alienate their support among the nations who participate in the indemnification pool.

Insurance availability provides some measure of security and can offset sociological impacts of terrorism. Terrorism insurance can similarly provide a backstop to rising anti-minority sentiment. For instance, one of the remarkable aspects of the response to terrorist attacks in the United States has been the outpouring of altruistic charitable funds established to compensate privately the victims of the attacks. Such funding has substantially reduced the amount of loss to insurers and government compensation schemes.[47] Such private funds signal not only broader popular support for the victims and the propriety of compensation for terrorist events, but also an appetite for voluntary assurance by society, and for an innate social desire to broaden and diversify the funding streams. In addition, these funds are voluntary, paralleling the international system of justice. A community of insurance-consumers is likely to be more vigilant and resilient to acts of terror.

Conclusion

A convention to create a global terrorism risk insurance system is not an all-or-nothing proposition. Particular threats, such as cyber, could even be carved out for special attention as the intrusion insurance market becomes more robust. Even if only a few states participate—member states of the OECD for example—there are diversification and counter-narrative benefits. Merely massaging existing schemes is unlikely to satisfy the need that the next crisis will create, or respond to what is happening today. Over time, an international convention could allow the scheme to evolve and adapt to the changing nature of terrorism threats, and grow into a robust security measure that demonstrates international solidarity, degrades the conditions that give rise to terrorism, and provides financial and psychological resilience across the world. The alternative is to be reminded that some twenty years after the international call for a comprehensive legal framework to combat terrorism, the risks of not creating one have become acceptable.