#04-04
"An Empirical Analysis of the Economic Impact of Federal Terrorism Reinsurance"
Abstract: This paper examines the role of the federal government in the market for terrorism risk, beginning with a discussion of the possible sources of market failure, with particular attention to whether terrorism risk differs from other large-scale natural catastrophes. We then provide empirical evidence on how the Terrorism Risk Insurance Act of 2002, which resulted in unprecedented federal intervention in the market for terrorism insurance in the U.S., was perceived by the markets. We examine the stock price response of affected industries to a sequence of thirteen events beginning with the initial proposals for a federal reinsurance role in October 2001 and culminating in the signing of the Act into law on November 26, 2002. We find that, in those industries most likely to be affected by TRIA – banking, construction, insurance, real estate investment trusts (REITs), transportation, and public utilities – the stock price effect was primarily negative. We argue that the Act was at best value-neutral for property-casualty insurers for several reasons including its elimination of the option not to offer terrorism insurance. The negative response of the other industries may be attributable to the Act's impeding the development of more efficient private market solutions and reducing market estimates of expected federal assistance following future terrorist attacks.
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