The role of insurance in managing extreme events: implications for terrorism coverage

The terrorist attacks on the World Trade Center and the Pentagon have created a heavy demand for insurance against such events. However, it is difficult to price insurance against extreme events because the probability of such events happening again is highly ambiguous, and the potential loss is highly uncertain. This paper explores the analytic issues that insurers must resolve in offering such insurance, including the calculation of premiums, the capital necessary to provide insurance, and options for raising such capital. It also explores the possibilities for public-private partnerships for providing such insurance if private insurers are unwilling or unable to do so, drawing on experiences of other countries. Finally, it identifies a number of issues that must be resolved before the private sector can provide insurance against terrorist attacks and other extreme events.