How Does the Corporate World Cope with Mega-Terrorism? Puzzling Evidence from Terrorism Insurance Markets

  1. Erwann Michel-Kerjan1,
  2. Burkhard Pedell2

Article first published online: 7 DEC 2006

DOI: 10.1111/j.1745-6622.2006.00112.x

Issue

Journal of Applied Corporate Finance

Journal of Applied Corporate Finance

Volume 18, Issue 4, pages 61–75, Fall 2006

Additional Information

How to Cite

Michel-Kerjan, E. and Pedell, B. (2006), How Does the Corporate World Cope with Mega-Terrorism? Puzzling Evidence from Terrorism Insurance Markets. Journal of Applied Corporate Finance, 18: 61–75. doi: 10.1111/j.1745-6622.2006.00112.x

Author Information

  1. 1

    Managing Director of the Risk Management and Decision Processes Center at the Wharton School. His work focuses on managing and financing extreme events. He advises firms, government agencies, and international organizations on these issues, including the OECD and the World Economic Forum. In 2005 he co-directed, with Howard Kunreuther, the Wharton initiative on the future of terrorism risk financing in the U.S. (TRIA and Beyond). He's the co-author, most recently, of Seeds of Disaster, Roots of Response: How Private Action Can Reduce Public Vulnerability (Cambridge University Press, September 2006).

  2. 2

    Professor of Management Accounting and Control at the University of Stuttgart. He has been visiting scholar at the Wharton Risk Center on a regular basis since 2002. His major research interests include rate regulation, risk management, and performance measurement. One of his recent publications is Regulatory Risk and the Cost of Capital: Determinants and Implications for Rate Regulation (Springer, 2006).

Publication History

  1. Issue published online: 7 DEC 2006
  2. Article first published online: 7 DEC 2006

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Terrorist attacks that have succeeded abroad since 2001, as well as others that were prevented, indicate that the threat of a large-scale attack is real and will be with us for a long time. Focusing on the United States, the United Kingdom, and Germany, this article analyzes the role that insurance can play in providing commercial enterprises with financial protection against the economic consequences of major terrorist attacks.

The article begins by explaining the design and key features of terrorism insurance programs operating today in each of the three countries (TRIA in the U.S., Pool Re in the U.K., and Extremus in Germany). The authors then provide a detailed comparative analysis of the evolution of prices and take-up rates (based on as yet unpublished data), with particular attention to financial institutions. For those who think the U.S. is the most likely target for mega-terrorism, the findings are somewhat puzzling. On average, for example, companies in the U.S. do not pay even half as much for comparable coverage under TRIA as companies pay in Germany under Extremus, which raises the questions: Is terrorism coverage under the U.S. insurance program now drastically underpriced? If so, what would be the likely consequences of another large-scale attack in the U.S.? On the demand side, the authors observe a dramatic increase in take-up rates in the U.S. since 2003, revealing increased corporate concern. By contrast, the market penetration in Germany remains remarkably low.

A better understanding of these programs and of the recent evolution of terrorism insurance markets in the U.S. and Europe should help corporate and government decision makers develop more effective protection against the economic consequences of mega-terrorism.

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