Terrorism Risk in a Post-9/11 Economy: The Convergence of Insurance, Capital Markets, and Government Action

Abstract

September 11 changed the American economy and the global insurance market. The insurance industry no longer covers terrorism risk for "free." The traditional insurance mechanism alone cannot spread the risk of repeated catastrophic losses. Beyond the Terrorism Risk Insurance Act of 2002 lingers the questions of a longterm solution and government's role therein. Government can assume different roles: reinsurer, wealth (re)distributor, regulator, or a combination thereof. This article suggests that the government should foster a regulatory and tax environment in which the private sector can develop a capital market solution for terrorism risk. Securitization is an alternative to reinsurance and can transfer risk to the global capital markets. Presently, this concept is just a theoretical possibility. Legal reforms must first reduce the cost of securitization and enhance the investment appeal, making terrorism bonds more price competitive with reinsurance. Even if such reforms are sown, a bond market will take many years to grow. Such a market, however, is impossible without the regulatory precursors, which are needed now.

Keywords: Terrorism, Terrorism Risk, Insurance, Insurance Securitization, Natural Catastrophe Securitization

JEL Classification: E6, G2, H2, H5, K1, K2, L5