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Report n°3: Financial protection of critical infrastructure

Insurance and extreme events

In this context, an analysis of large-scale risks, such as major natural disasters or mass terrorism, must be undertaken in a very special way. The economic and social development of a country or of a region depends on uninterrupted access to essential needs. However, such catastrophic events are capable of inflicting considerable human and financial loss, with irreversible social repercussions, thus significantly curtailing the prospects of sustainable development for the afflicted sectors of activity.

Furthermore, such large-scale risk, or interactions between these various categories of risk, also carry the essential attributes of collective ills, within the meaning of the economic theory of non-rivalry and non-exclusion i.e. everyone is potentially under threat, and the threat for some does not necessarily lessen the threat for others. Finally, such risks impose definite restrictions on insurers because they constitute a potential for very substantial losses which could lead to ruin, and they are highly uncertain and ambiguous (within the meaning of uncertainty and ambiguity in decision theory).

For those reasons, the creation and implementation of adequate financial coverage for such events are increasingly a subject for national consideration well beyond the scope of the insurance industry alone(9). It is worth noting that the series of hurricanes which devastated the coast of Florida last August and September caused almost 25 billion dollars' worth of insured amounts, and contributed to making 2004 into the most costly year in the whole history of global insurance and reassurance.

To date, the large-scale attacks on the United States on the morning of September 11, 2001 remains the most costly event in the entire history of the industry. These attacks and later ones, including the events in Madrid on March 11, 2004, have served to highlight several essential issues regarding the insurability of catastrophic risk. An analysis of terrorism as part of the problem of "Protection of critical infrastructures" shows that terrorism is now a recognized source of acute risks(10), those which are closest to the outer limit of insurability. And this is true, we believe, to an extent which no other risk raises.

It therefore seemed pertinent, in the framework of the research supported by the Ecole Polytechnique's Chair on Sustainable Development, to further analyze the issue of uncertainty and insurability through the emblematic example of large-scale terrorism.

The 2001 terrorist attacks were unprecedented in a country at peace: first of all by the number of deaths to be deplored following the collapse of the twin towers of the World Trade Center, the aircraft crashes onto the Pentagon and in Pennsylvania, and fatalities within the ranks of the emergency services, altogether more than three thousand dead. Unprecedented also because the targets were not only public properties representing governmental power or public security (the Pentagon, airspace), but also private property destroyed by private commercial aircraft. In view of the impact of such attacks of a new kind, the act of terrorism - in a multiplicity of possible forms - has become a new source of "large-scale damage".

These events have had a very singular resonance effect and have raised a multitude of questions as regards the nature of terrorism today, the responsibility of governments to guarantee the security of their citizens, the impact of their foreign policies, inter alia. More specifically, and focusing on the subject of this paper, they have also highlighted the issue of the financial liability of governments and of the private sector to guarantee compensation for victims (personal and corporate), and thereby the social and economic continuity of the country. The question of financing the consequences of such events - and therefore of ex ante risk-sharing - then emerges as a central issue, and we shall focus our analysis of terrorism on that aspect.

(9) Let us take note here of a crucial point. Insurance is no more than one type of financial instrument that a company can use to ensure coverage; there are others such as self-insurance, debt emission, or equity issue. (Doherty, 2000).

(10) The notion of "acute risks" complements the notion of "diffuse risk"; the latter may appear effectively over a fairly long period of time, sometimes several years (pollution of air or of the soil, physical exposure to certain types of asbestos, or so-called "development" risks).