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Report n°3: Financial protection of critical infrastructure

Conclusion and Perspectives

An examination of the terrorist issue highlights some specific aspects of the problems attached to financial protection for large-scale infrastructure. This risk is now recognized as being situated at the outer limit of insurability of sporadic disasters by the insurance and reinsurance markets on their own. This is particularly true in the face of terrorism that we now know can strike on an entirely different scale, as is also the case -or even more so - of other events such as natural disasters, major industrial accidents or epidemics.

We have purposely limited this report to the issue of insurability, but it must be kept in mind that it is an integral part of a complex social, economic and political mosaic of risk management. Because this is so, the question of resource allocation (public or private) is essential, resources being limited by definition. How much should be set aside for advancing knowledge on the risk itself? For elaborating adequate prevention measures? For collective preparation to deal with this type of extreme situation(30) ? For their financial coverage?

The catastrophic events alone of December 26, 2004, in South-East Asia killed nearly 300,000 people, according to the latest official estimates. The amounts insured themselves were limited. The heat wave in France in August 2003, killed, according to figures provided by the Commission of Enquiry of the National Assembly, almost 15,000 people; the question of insurance coverage was never mentioned. Let us therefore remember that the yardstick "insured damage" never reflects more than partially the extent of damage brought about by the catastrophe. It is therefore not always fully representative of the scale of destabilization.

For a growing number of people and firms, increasing globalization of activity makes it easier to access essential goods. However, globalization also means that there is more interdependence between risks, industries, and countries; a globalization of vulnerabilities in other words, since propagation of the disaster will have almost immediate consequences for a great many other actors.

What is surprising today is the scale on which we need to rethink risk management mechanisms to adjust them to this evolution. We also need to accept that management will have to work with a non reducible level of uncertainty. We have moved from the local approach to mandatory international vision in a universe of considerable uncertainty and growing interdependence. More than anything else, this is probably one of the fundamental characteristics of what we are now accustomed to calling the "new risk" (31).

Some future prospects
In May 2002, Ministers of the 30 countries who are members of the Organisation for Economic Co-operation and Development (OECD) gave the OECD a special task, i.e. to analyze the issue of financial coverage of catastrophic risk, and mega-terrorism in particular (OECD Task Force on Terrorism Insurance(32). As part of this activity, an international conference convening members of the Task Force and more than a hundred specialists (from governments, firms, research bodies) was held at the end of 2004 at OECD headquarters in Paris.

(30) As an example, it was often repeated that the Mayor of New York, Rudolf Giuliani had managed the crisis situation particularly efficiently. What is less known is that during his mandate the Mayor participated in a monthly crisis exercise with his staff. In particular a large scale exercise simulating chemical attack on the city was organized in July 2001. Afterwards, a repeat exercise was planned to measure improvements in the actual preparation of all personnel concerned. The date for this new large scale exercise had been set: September 12, 2001. It would be interesting to find out how many mayors in large European capital cities had participated during the past year in non traditional crisis management exercises in collaboration with a large number of agents who would be mobilized in the event of a major incident. Good crisis management cannot be improvised - it has to be prepared.

(31) Godard et al. (2002). From a scientific view point, these risks raise essential issues because the traditional use of actuarial instruments is, at best, very questionable. Therefore, despite the occurrence of a growing number of particularly devastating disasters over shorter and shorter periods of time, expertise on theses subjects is still paradoxically very limited, and too often focused on a very restricted sub-set of the matter in hand.

(32) The mandate stated in particular: "We recognise the adverse effects of the shrinkage of affordable insurance cover for terrorism risks. We would welcome OECD policy analysis and recommendations on how to define and cover terrorism risks and to assess the respective roles of the insurance industry, financial markets and governments, including for the coverage of "mega-terrorism" risks". Erwann Michel-Kerjan is one of the 5 international experts serving on the Task Force.

They underscored particularly several of the points made in this paper: emergence of a broader spectrum of large-scale risks, limited possibility of using traditional actuarial instruments to quantify the risk, limited possibility of risk coverage provided solely by the insurance and reinsurance markets, need for further study of these matters of concern for individual countries and the international community so as to be better prepared to develop new coverage solutions involving interaction between the private sector and governments (see also OCDE, 2003).

Recent developments show more and more crises affecting industries in various areas. Company managers must therefore be proactive and prepare their organisation as best they can to respond to such major upheavals.

Let us also bear in mind one fundamental aspect: these new risks can also be a source of significant opportunities (strengthening of position, opening of new markets, consultancy, etc.).

Recently, several major corporations have taken due note of these opportunities and in the last three years have engaged in serious thinking leading to concrete actions supported by their top management. In a context of increased international competition, they have gambled on strengthening their leadership position by including in their strategy the issue of managing and funding emerging risks. Remarkably, the issue is not usually under the control of risk managers but rather part of the agenda of Boards of Directors and Management Boards.

The State has a major responsibility to guarantee the economic and social continuity of their countries in the face of these new "large-scale risks" to which is associated a high level of uncertainty - or even ignorance. In the circumstances, the time has come when it is no longer sufficient to see the role of government intervention purely in terms of offsetting market shortcomings, but when there is a need to pioneer systematic moves in the direction of new economic policies, i.e. the creation of collective actions based on partnerships between the private and public sectors, and combining the catalyst effects of each sector.

Protection of major critical infrastructures - frequently run by both the public and private sectors - is a highly legitimate domain to apply such an approach. National interests are at stake.