Terrorism and Insurance

Terrorism is a grave risk that is being faced by the entire world. When an event related to terrorism occurs, the losses faced by certain individuals or groups of individuals are catastrophic.

The loss of human life is an obvious and sad outcome of terrorist attacks. However, the financial losses can also be significant. Increased incidents or terrorism lead to falling investor confidence. As a result, the overall economy of the nation can end up being damaged.

Consider the case of Pakistan, where investors are not willing to invest any of their money for fear of terrorist attacks. The end result is that the entire economy is in doldrums and Pakistan basically survives on foreign aid in spite of having all the resources required to have a bustling economy.

However, investors are not at fault either. It is very difficult to invest in an economy where acts of terrorism can end up disrupting the supply chain. Also, it is important to note that businesses or individuals cannot really protect themselves from risks that arise due to terrorism.

Most standard insurance policies exclude terrorism and risks or war from their coverage. There are some special policies which provide this coverage. However, such policies are few and not really dependable.

In this article, we will have a closer look at what terrorism is from the point of view of insurance. We will also try to understand why terrorism is not covered in most standard insurance policies.

Definition of Terrorism:

There is no standard definition of terrorism. Any act of violence which is carried upon non-combatant people by non-state actors is called terrorism. This includes acts of violence using chemical, biological and cyber weapons. These acts of violence are usually designed to intimidate people and influence certain political policy decisions.

It is important to note that the definition includes loss to humans as well as to property. However, it is also important to note that the definition mentions terrorism as an act being conducted only by non-state actors.

Acts of violence conducted by state actors are termed as war. However, from the point of view of insurance coverage, there is not much difference. Most policies which exclude acts of terrorism from their coverage also exclude acts of war.

Reasons Why Terrorism Is Not Covered?

Insurance companies are happy to cover most unforeseen events in exchange for a premium. However, they are not willing to cover acts of terrorism because of the following reasons mentioned below:

• Lack of Data:

  Insurance companies need empirical data in order to ascertain risk. A huge collection of this data allows insurers to make an educated guess about the number and magnitude of claims to expect. In the absence of such detailed data, there is no way for the insurers to find out the real risk that they are assuming in issuing a policy.

  Insurers look for data relating to the frequency and severity of terrorist attacks. However, in advanced western countries such as the United States, this data is scarce. Also, the severity of terrorist attacks in the past is no indication of the possible severity of terrorist attacks in the future.

  Hence, in the absence of data, it is not possible to know the exact amount of premium that can be charged in order to cover the risks. This is one of the reasons why acts of terrorism are not covered under standard insurance policies.

• Not Random:

  Insurance is meant to cover random and accidental events. Acts of terrorism are not really random. They are intentionally designed to inflict maximum damage at a certain location. Also, these events are not really accidental.

  Since terrorism does not fit the list of events that can be covered by insurance, companies usually back out. If insurance companies started covering the risk of events that are deliberately done, they would soon be bankrupt. Insurance is meant to cover damage from uncertain events and not damage from events that will be done certainly and willfully.

• Risks Not Spread Out:

  Acts of terrorism generally happen within some geographical area. There are some areas in the world, for instance, the Middle East and the Afghanistan-Pakistan border, which are much more susceptible to terrorism than other regions.

  This is not suitable for insurance. For insurance to operate successfully, the losses should not be concentrated in a geographical area at the same point of time. Such concentration could end up bankrupting the insurer. This phenomenon is known as “Accumulation of risks” in insurance parlance. This is the type of risk portfolio that insurance companies want to stay away from at any cost.

• Adverse Selection:

  There is another problem called adverse selection which affects terrorism insurance as well. Any kind of insurance works when most people who are not going to obtain a claim pay in the premium.

  For instance in health insurance, if 100 people pay a premium, maybe 5 file for a claim. On the other hand, since terrorist events are concentrated in certain areas, only people from those areas will buy a policy. Hence, pretty much anyone that buys a policy will end up making a claim. This is called adverse selection and once again, insurance companies avoid it like the plague!

To sum it up, there are multiple reasons why acts of terrorism are basically an uninsurable risk. Hence, it is not really likely that with the advent of time companies may start offering coverage for insurance.

Authorship/Referencing - About the Author(s)

The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.