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Report n°3: Financial protection of critical infrastructure

Commercial terrorism insurance in France (Gareat)

Context
In the French context of the law dated September 9, 1986, which makes it mandatory for insurers to include terrorism coverage in property and casualty policies, discussions took place in the fall of 2001 between representatives of insurance companies and mutual companies (FFSA - Fédération Française des Sociétés d'Assurance/association of French insurers - and GEMA - Groupement des Entreprises Mutuelles de l'Assurance/association of French mutuals) and the Treasury. France had already suffered several waves of deadly attacks, and the AZF chemical factory explosion in Toulouse, in circumstances which are still unexplained, reinforced fears of new attacks on French territory. Finally, an agreement was signed on December 10, 2001, for the creation of a commercial insurance program against terrorism based on a public-private partnership: a pool of co-reinsurance, GAREAT (Gestion de l'Assurance et de la RÉassurance contre les Attentats - management of insurance and reinsurance against terrorist acts), with unlimited guarantee provided by the French government above a certain threshold. By the creation of the first terrorism insurance pool in the world post 9/11, France has guaranteed the continuity of coverage offered to corporations.

Structure of the partnership
GAREAT, is a co-reinsurance pool set up January 1, 2002. It is structured as a four-layer risk sharing system, with annual aggregate stop loss coverage. (Figure 3).

The french co-reinsurance pool Gareat.

There have been several changes to the pool during the first three years of its life. The following has been up-dated to the mode of operation in 2004. Risk-sharing is obtained by four successive layers of exposure. Insurers may transfer their terrorist exposure to the pool which therefore operates like a reinsurer.

A first layer of 400 million euros is covered by the insurers in proportion to the risk assigned to the pool. Seventy non-life insurance companies and mutuals, members of FFSA and GEMA for whom participation is mandatory, and thirty-five other volunteers make up this first layer. A second layer is covered by reinsurers and other large insurers. They are responsible for 1.25 billion euros coverage with annual stop loss set at 400 million. The Swiss reinsurance company (Swiss Re; second largest reinsurance company world wide after Munich Re) covers the greater part of this second layer, in partnership with thirty other companies including AGF, Axa, Scor and also Partner Re and Munich Re.

As shown in figure 3, a third layer provides additional covered of 350 million euros, and is taken up by several major international reinsurers.

Therefore in total, the insurance and reinsurance industry cover the terrorist risk in France up to 2 billion euros. Beyond that (4th and last layer) the French government covers all insurance compensation required as a result of terrorist attack through the Caisse Centrale de Réassurance (CCR). The government guarantee is unlimited which is a fundamental component in a shared risk approach. As we have seen, the extreme character of potential loss connected to terrorist action is what fundamentally limits insurability. In the French system, the risk is limited to two billion euros, an amount that the industry can cope with, particularly if the risk is disseminated among a large number of risk-takers, as is the case with Gareat.

Premiums collected by insurers are transferred to Gareat and shared in the following way: the pool retains 30%, participants in the second layer keep 50%, reinsurers in the third layer keep 10%. Finally, the government receives 10% of premiums in exchange for unlimited guarantee.

Terrorist cover
Insurance against terrorism is compulsory in France, so that all firms are covered against terrorist action on French territory. Insurers may then reinsure with the pool subject to the risk meeting the following criteria: the risk must be located in France, amounts insured in excess of 6 million euros (property and casualty, fire). In other words, the pool offers mutualization for medium and large risks, but does not cover the "small risk". Also noteworthy, the pool provides coverage for attacks using chemical, biological, radiological and nuclear weapons of mass destruction, whereas this type of cover is extremely rare in the United States for example.

 In the previous section, we mentioned the difficulty of quantifying terrorist risk, and therefore of pricing cover. For that reason, and also because it is easier to manage, pricing of terrorist cover by Gareat depends on a single input: sums insured. As these are identical for terrorist cover and basic fire insurance, the price of terrorist insurance is very easy to calculate in France. The system is based on the following rule:

  • for sums insured comprised between 6 and 20 million euros, the premium is equal to 6% of the property and casualty line basic commercial coverage premium;
  • for sums insured comprised between 20 and 50 million euros, premium is equal to 12% of the basic commercial premium
  • for sums insured comprised between 50 and 750 million euros, premium is equal to 18th of the basic commercial premium.

For certain so-called "special" risks (sums insured for more than 750 million euros, captives) the premium is defined on a case by case basis.

In France therefore, the price of insurance against terrorism does not depend on the location of the risk. An insurer covering a chemical factory for 20 million euros will pay the same premium for reinsurance with Gareat for transferring the risk, regardless of whether the plant is located in the cluster of chemical industrial activity near Lyons (where there is a concentration which could be a prime target) or in rural isolation (where at first sight the risk of attack seems lower).

This method means that the system is subsidizing areas which are over exposed at the expense of those which are not. Based on a notion of national solidarity in the face of catastrophe, this method was not followed everywhere. In particular, there is ongoing debate on this subject in the United States (Kunreuther et Michel-Kerjan, to be published).

Altogether, in 2004, the total amount of premiums collected by Gareat is estimated at 260 million euros. The price of terrorist coverage, the ratio of total premiums collected to total sums insured, is estimated at 0.01% (i.e. 10,000 euros in premiums for 100 million euros insured).

The demand for insurance
Since terrorist insurance is mandatory in France, all firms are covered. By making insurance compulsory, it is possible to limit counter selection which would lead to a very weak market in which only the poor risks are covered. This is discussed below in the context of an analysis of the German market which in fact seems to be plagued with that problem.

It is however difficult to compare the Gareat pool system with compulsory insurance to what the French market would be if there was no obligation to insure. In fact, simply because the price of insurance against terrorism does not depend in the least on the degree of exposure to risk (location, interdependence, for example), nor on preventive action, there is no incentive to gain better knowledge on the risks incurred by companies working in France. A "veil of ignorance" is hardly compatible with the establishment of a competitive market. Even if firms prove to their insurer that they have invested in sophisticated security, or even relocated their business so as to leave behind them potentially more exposed built-up areas, they would not get a reduction in the price of premiums. In that context, it is hardly expected that the main modeling companies such as AIR, EQECat and RMS do not operate in France as regards their terrorism related activities. However, without better insight in exposure and realistic threats (at least in terms of the relative likelihood of a large number of attack scenarios) there can be no economic evaluation of the existing system .

Temporary and renewable partnership
Initially, the pool was created for one year, so as to give insurers time to be clearer about their commitment and how to develop suitable strategies in the face of the new terrorist threat. At the end of 2002, the partnership between the government and the private sector was prolonged for a further year. At the end of 2003, after two satisfying years of operation for all stakeholders, the partnership was again renewed, but this time with a three year term until the end of 2006.

Renewal was combined with several changes as regards the risk sharing thresholds. When the pool was launched in 2002, the private sector provided coverage up to a billion euros and CCR could consent zero percent interest loans reimbursable over ten years to insurers and reinsurers in the event that reimbursement amounts exceeded a billion euros (500 million euros in excess of a billion euros). In order to limit government commitment to large-scale attacks only, the threshold for government intervention was gradually increased and finally reached the 2 billion euro level in 2004. In the meantime, new private partners joined the program.

Three years on from the creation of Gareat, in the absence of any major terrorist attack on French territory, accumulated reserves should enable the pool to increase its retention level in the near future(29).

(29) For an analysis of the system for covering victims (commercial insurance) see the last chapter of Godard, Henry, Lagadec and Michel-Kerjan (2002) and SOS Attentats (2003).