Transcript Supply Chain Response to Global Terrorism: A Situation Scan ISCM Sponsors

Supply Chain Response to Global Terrorism:
A Situation Scan
Insurance and Risk Management Response
A Research Project Update to
ISCM Sponsors
by
The SC Response to GT Team
October 16, 2002
© MIT 2002
Outline
• Terrorism and the Insurance Industry
• Defining the problem.
• Risk Management
• Modeling Solutions
• The Future
• New Modeling Solutions
© MIT 2002
Foundation of Observations To Date
• Print References
• 1400+ pages of Insurance/Risk Mgt Industry reports
• 2 Books
• When All Else Fails (David Moss: Harvard Business School)
• Making the Nation Safer (National Research Council)
• Relevant Journals, Periodicals, Research Papers
• E.g. Risk Analysis, Journal of Risk and Insurance, Journal of Risk
and Uncertainty.
• On-Line References
• 50 Insurance Industry Websites
• Interviews
• 11 interviews with Terrorism/Risk/Insurance Experts
• Assistance from 3 Consulting Firms
• Seminars
• 2 Seminars on 21st Century Terrorism in the U.S.
© MIT 2002
Defining the Problem
• September 11 changed the underlying assumptions of
terrorism risk and insurance economics.
• $56B estimated losses from WTC exacerbated a previously
existing problem
• Unsatisfactory return on capital for insurers before 9-11-01
• Much of the loss will be paid out of the industry capital account
• Result
• Coverage eliminated on many policies after 1-1-02 renewal date
• Premiums raised on other policies for substantially less coverage
• Impact on commerce
• Airline industry* to pay $1B premium increase in 02
• Increased risk aversion has negative impact on economy
• E.g. Some lenders are assessing properties for terrorist risk, and
are not lending to trophy properties not adequately insured
* Per US Dept. of Transportation
© MIT 2002
The Crux of the Problem
• The potential damages have been revealed to
be so high that the US Government has a new
role
• “There is no company or group of companies that
has the resources to assume such a risk, even
though all concerned have unthinkingly been
doing so. The only viable re-insurer for truly
large-scale terrorism is the U.S. Government.”
• E.g. If the attack in NY were nuclear, damages of $1T
total far exceeds the aggregate capital of the world's
insurance companies*
* Source: The Chairman: Warren Buffett
© MIT 2002
Potential Solutions
• “Shared Loss Compensation Program”
• Proposed by Treasury Secretary Paul O’Neill
• Program between private insurance companies and the
Government.
• Government will assume a significant percentage of the
liability for the next terrorist attack.
• Government involvement would sunset after 2004
• A temporary solution, limiting Government involvement
• Concept is to provide Insurance industry time to develop a
new risk management scheme that incorporates terrorist
activities
© MIT 2002
Shared Loss Compensation Program
• (2002) GOV
80% of 1st $20 Billion
90% of $20 Billion +
• (2003) GOV
00% of 1st $10 Billion
50% of $10B – $20B
90% of $20 Billion +
• (2004) GOV
00% of 1st $20 Billion
50% of $20B – $40B
90% of $40 Billion +
© MIT 2002
Assessing The Risk As We Now Know It
• Swiss Re officials speculate
• It could take three to five years for the private insurance
industry to develop the means to cover terrorism
• Using an approach that is similar to that used with natural
catastrophe risks
• The Risk as We Now Know It
• Historically, terrorist groups seeking to attack the U.S.
generally target business.
• Since 1968 when the government first started tracking terrorism,
80 percent of attacks on U.S. interests have been on businesses*
• Models actively used to analyze and assess
*Ambassador L. Paul Bremer, Chairman of the Crisis Consulting Practice at Marsh, Washington, D.C.
© MIT 2002
Assessing the Risk
• Commonly-held opinions in the industry
• Terrorism risk is not insurable because it cannot be
quantified
• Modeling companies and insurers, however, are beginning
to develop new tools for analyzing the risk in the hopes of
bringing clarity to the process
• Modeling Solutions
• First define the problem
• The next step involves soliciting various perspectives
• Interviews with leaders from industries and government
• Focused research on potential solutions
© MIT 2002
Modeling Solutions – Four Key Issues*
• Where attacks might occur
• What form attacks might take
• What the probability is for a particular attack
on a certain location
• I.e Modeling the terrorists.
• How to translate such an attack into damages
*Per Guy Carpenter
© MIT 2002
Modeling Solutions – Three Service Waves*
• First Wave
• Customized exposure mapping and scenario analysis with
Geographic Information Systems (GIS)
• Highlight certain buildings or infrastructure features as
potential targets, then see how exposures are distributed
• Second Wave
• More formalized tools for accumulation control, building
on GIS by automating “what-if” scenarios and making
tools more user-friendly
• E.g If a car bomb were set off at a certain location, what would be
the consequences for a particular set of insured exposures?
• Third Wave
• Complete probabilistic models
• Much more sophisticated and similar to the models
currently used with hurricanes and earthquakes
*Per Guy Carpenter
© MIT 2002
Three Largest Risk Modelers
• Applied Insurance Research (AIR)
• Extends its existing natural catastrophe models
• Catastrophe modeling firms have inventories of
commercial & residential building stock, & info on
infrastructure (bridges, tunnels, port facilities, etc.)
• Eqecat
• Uses a pure probability model with property
damage functions based on historical and test data
• RMS
• Game theory approach: model future targets by
understanding operational and behavioral
characteristics of terrorist organizations
© MIT 2002
RMS Solution
• RMS Terrorism Risk model supports high-resolution
analysis at latitude/longitude or street address level.
• Estimates the probability and cost of property
damage, business interruption, and casualties caused
by 16 different 'modes' of terrorist attack
• Includes conventional explosives and weapons, and
chemical, biological, radiological, nuclear scenarios.
• E.g. Based on understanding that Bin Laden is rational. He
is a Saudi citizen who wants to remove the King but is
unable to do so because of US interference.
© MIT 2002
Target attack vs. Smaller attack vs.
Biological/Chemical attack.
© MIT 2002
Eqecat Solution
• Eqecat has developed a model on the basis of
pure probability. Used consulting firms to
quantify the likelihood of an attack on a
specific target. Those targets are assigned a
hierarchical value .
• Over 10 million events and hundreds of
thousands of high probability terrorism target
sites.
© MIT 2002
AIR Solution
• AIR’s approach involves extending its existing
natural catastrophe models to deal with
terrorism.
• The model selects hundreds of thousands
different targets and attack possibilities.
• Specialists in terrorism help choose these
targets. From this database, probabilistic
losses are determined.
© MIT 2002
How is damage being calculated?
© MIT 2002
Can Terrorism Risk Be Modeled?
• Skeptics say that the main reason why
terrorism risk cannot be modeled is that
historical data is needed.
• For example, when natural catastrophes are
modeled, many criteria are taken into account
but historical data is crucial. A probabilistic
model cannot be created without it.
© MIT 2002
Models All Based on Historical Data
• Eqecat’s probabilistic model property damage
functions are based on historical and test data.
• AIR gets information from its location
database, applies the specialists’ knowledge,
and from this generates probabilities.
• RMS – based on game theory, which suggests
that the targets of future attacks and likelihood
of success can be modeled by understanding
operational and behavioral characteristics of
the terrorist organizations.
© MIT 2002
Shortcomings
• All three models assume TARGETS.
• Very little consideration is given to bombing a
daycare center or a school.
• Even a Chemical-Biological-Radiological (CBR)
attack is based on the assumption that it will occur in
a heavily populated “target” location.
• No consideration for a terrorist who assembles and
detonates a Weapons-of-Mass-Destruction (WMD) in
the privacy of their apartment.
© MIT 2002
New Modeling Solutions
The Lowtan Plan for Modeling Risk
(Still adapting from undersea to above ground)
NOT YET AVAILABLE
But there are other solutions being considered….
© MIT 2002
Some Proposals for New Solutions
• Accept view that no company (or group) is capable of
assuming the risk of insuring the potential damage
from a nuclear WMD.
• If a terrorist detonated one nuclear device, it would only
cost U$1 Trillion. What if 3 or 4 devices were detonated?
• Insurance companies could adopt the attitude that the
Government designed and built most nuclear WMDs, so it
the Government should assume responsibility.
• Offer a variety of insurance packages to various
businesses – with or without terrorist risk policy.
• Model several options that separates between large
and small scale attacks, insure against different
attacks.
© MIT 2002
Some Proposals for New Solutions
• Develop a simple, understandable manageable
spreadsheet model for insurance companies to
use to set premiums.
• Allow individual customer companies to
choose which terrorist package is appropriate
for their business.
© MIT 2002
Requirements for New Solutions
• Industry needs to be able to trust the insurance
system to remain solvent after a crisis.
• Otherwise, what is the point of purchasing
insurance?
• Terrorism Risk can turn into a profitable
venture for insurance companies.
• In turn, businesses can have more faith in the
insurance industry.
© MIT 2002
Questions for Industry
• How does your firm think about the role of the
Government acting as insurer of last resort?
• How is your firm modeling risk in its supply chain?
• How is your company protected and insured against
an attack on your supply chain?
• Targeted disruption of distribution system
• Targeted disruption of production and supply system
• How is your company protected and insured against
an attack on your products?
• Targeted product contamination
© MIT 2002
Thank You
• Questions or Comments?
© MIT 2002
Companies Providing Valuable Assistance
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International Security Technology, Inc.
RMS (Risk Management Solutions)
PricewaterhouseCoopers
FTI Consulting
MIT Security Studies Program Office
© MIT 2002
Online Resources
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Berkshire Hathaway
Guy Carpenter
Tillinghast – Towers Perrin
Risk and Insurance
© MIT 2002