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Insuring against the worst

Calculating the risk of a terrorist attack isn’t easy. Extremus, the only German insurer that covers such losses, tries anyway.

Three decades in the insurance business make you unperturbed: Gerhard Heidbrink, chairman of the managing board of Extremus, and Leo Zagel, managing general agent.

• For 14 years all was well. Then, at about 8pm on 19 December 2016, a 24-year-old Tunisian drove an articulated lorry into a busy Christmas market on Breitscheidplatz in Berlin. With his lights turned off, he mounted the kerb beside the Kaiser Wilhelm memorial church. Twelve people died and more than 50 were injured.

The following morning, in an unremarkable office building on a four-lane road in Cologne, one question loomed: do we have to pay? And if so, how much? The worst-case scenario for Leo Zagel and Gerhard Heidbrink had just happened.

Extremus, founded in 2002, is the only German insurance company prepared to insure its customers against material damage caused by acts of terror. So the first thing they did in Cologne after the attack was to check the insurance on the surrounding buildings. As it turns out, Breitscheidplatz is one of 125 sites in Germany with a particularly high concentration of material assets. That is to say, the total value of the insured buildings within a radius of 200 metres is more than €1bn (£890m).

Heidbrink, the 66-year-old chairman of Extremus, and his 72-year-old colleague Zagel, the managing general agent of the company, exude the sense of calm that one presumably develops after working in insurance for more than three decades. On the day after the attack, they sent an evaluator to Berlin to determine the extent of the damage. Just from the television reports, however, it was clear that the attack would not be as costly in material terms as it was in lives. Although the terrorist had destroyed a number of the stalls in the Christmas market, there had been no explosion and little damage to surrounding properties. The lorry did not hit any buildings, coming to a standstill on Budapester Straße, right in front of the Bikini mall.

In the end, the only damaged property insured by Extremus was one of the market stalls. “The extent of the damage was so small that the claim remained below the €50,000 deductible,” says Heidbrink. As a result, Extremus did not have to pay out a single euro for the terror attack. And this has been the case ever since the company was set up, even though it specialises in what is perhaps the most challenging field for an insurance company.

The insurance business is based on assessing risk. Earthquakes, storms, flooding, tsunamis, forest fires and other such recurring phenomena can be appraised fairly accurately using statistics. The same is true of damage caused by human beings (provided it is unintentional), such as damage due to water or fire, and car accidents.

Jörg Reinecke, underwriter, decides the price of policies

However, when damage is inflicted deliberately, the situation is different. Such risks stubbornly resist actuarial attempts to describe them in terms of mathematical equations. There are no stable averages or empirical values on which to base serious predictions about the future.

Being able to insure against damage caused by terrorism at all is a relatively new development. Insurers in the UK first began to offer this type of policy in the early 1990s because terrorism had reached a new level. Until then, the biggest damage had been caused by bombs on aeroplanes, but those claims rarely exceeded $100m. Then, in 1992 and 1993, the Irish Republican Army (IRA), a terrorist group in Northern Ireland, carried out a series of bomb attacks in the City of London, causing more than £1bn of damage, as well as killing four people. Also in 1993, the first attack was carried out on the World Trade Centre in New York, causing $725m worth of damage and killing six people.

The attack on the Twin Towers on 11 September 2001, which claimed 2,977 victims, exceeded anything previously thought possible by a small group of terrorists. The insurance claim was calculated by the US Insurance Information Institute to come to a stupefying $32.5bn. Three European insurance companies – Allianz, Munich Re and Lloyd’s of London – had to cover about $8bn. Until then, damage caused by terrorism had been covered by fire insurance policies, but German insurers realised they needed a large, comprehensive solution to this problem.

Sharing risk
The insurance industry spreads risk rather like mountaineers do: by roping themselves together. Companies sign contracts with reinsurance companies, which pay back some of the insurer’s losses in the event of a claim. After 9/11, however, reinsurers cut the ropes to avoid being dragged down themselves. No one was prepared to cover contracts that continued to offer a payout in the event of a terror attack; the risk seemed incalculable. “If a major terror attack had taken place in Germany during that time, insurance companies might have found themselves in serious financial difficulty,” says Heidbrink, who attended the crisis meetings of insurance companies at the time.

The initial reflex of several German companies was to stop including protection against terrorism altogether. However the German government would not accept this, arguing that one must never give in to terrorists. The Federal Ministry of Finance, then headed by Hans Eichel, made it clear that it was not prepared to accept a “market failure”.

The solution ultimately lay in acting as a community. If the risk was virtually impossible to calculate, said the insurers, it must be spread across many shoulders. Sixteen Germany companies got together to form Extremus – including Allianz, Munich Re, Swiss Re, and HDI-Gerling – allowing them to guarantee €2.5bn a year. Each company participates in line with its own market share. The bigger partners, Allianz and Munich Re, each cover 16%; the significantly smaller companies, such as Signal Iduna and DEVK, each cover 2%. The government guarantees a further €7.5bn on top of this if the damages incurred in the course of a year exceed €2.5bn.

Zagel and Heidbrink were among the German “founding fathers”, as they like to put it. Heidbrink took part in the negotiations as a member of the HDI managing board, while Zagel was on the board of Gerling. They agreed that Extremus should only cover material assets worth more than €25m. Where the value was less, the insurance against terrorist attacks would continue to be included in fire insurance policies. Primarily, they cover the office buildings, factories and warehouses owned by medium-sized to very large enterprises. From the start, the lion’s share of turnover came from a small number of highly lucrative contracts with major German companies.

Today, Extremus employs 13 full-time workers. It has signed 1,343 individual contracts with companies and insures a total of 7,805 “locations at risk” throughout Germany, with a total value of more than €650bn.

Strange as it may sound, one of the strong points of the company is the fact that every employee is very aware of how little solid data is available. “There simply is no reliable statistical material,” says Zagel. “And we cannot see inside the minds of the terrorists.” This is why Extremus pays particularly close attention to what it does know: where an attack is likely to occur.

Eight underwriters at Extremus have the task of assessing terrorist risks and drawing up policies. One of them is Jörg Reinecke, a lanky 43-year-old with thick spectacles and an ageless face. The first thing he needs from a client is a list of all the buildings to be insured. He then draws a circle with a radius of 200 metres around each one on a map and calculates what it would cost if all the buildings within that area were badly damaged in an attack.

At Extremus, this is known as the “accumulation zone” – an area in which all buildings could theoretically be affected by the same explosion. The most expensive accumulation zone is worth between €3bn and €5bn  and lies in the centre of Germany’s financial hub, Frankfurt am Main. The more highly concentrated the asset values are, the more the policy costs the customer. There are two reasons for this: firstly, as terrorists are out to cause maximum damage, districts like this are considered particularly high risk. And if something does happen there, the result will be a great deal more expensive for Extremus than if they were only dealing with a single building.

The underwriters have a lot of leeway in setting the price of the policies, to take all this into account, says Reinecke. “This is different from a fire insurance policy, where the price is calculated using objective criteria, such as sprinkler systems and fire doors. We have to make a lot of gut decisions.”

Underwriters can lower or raise the price by a factor of 10, if they think this appropriate. “The premiums we set all lie between 0.3 per mille  of the insured value, for the most expensive, high-risk buildings, and 0.03 per mille for the cheapest – someone insuring a building in the open countryside, for instance.”

A building worth €100m on the rural Lüneburg Heath, for example, can be insured against terrorist attacks for just €3,300 a year, whereas buildings in the inner cities of Hamburg, Berlin, Munich or Frankfurt are considered high-risk. The same is true of places where crowds gather: airports, football stadiums, museums, railway stations and shopping centres.

Risky products, pay more
It is not simply a question of location though. Extremus was recently approached by the manager of a metalworking company. Its factory was out in the countryside, but it produced parts for an arms manufacturer, which in turn supplied weapons to a country where a military conflict might erupt. In the end, the insurance premium that the company was asked to pay was more than twice what a manufacturer of uncontentious products in the same region would have been charged.

At the same time, Reinecke knows that he must not make the premiums too high, because there is increasing competition on the market. “Lloyd’s of London, in particular, has made us lower our prices further and further in recent years. If the insurance policy is too expensive, the customers will naturally go somewhere else.”

This is also the reason why Extremus’s turnover has dropped by almost €20m over the past 10 years – to €43.8m in 2016 – despite having signed 200 additional contracts over the same period. Its most recent operating profit came to €300,000; but those in charge are less concerned about generating a surplus than minimising the risk. There are upper limits on the damages payable, there are accumulation zones and clearly worded contracts. “The main thing is that each of the 16 insurance companies involved now knows exactly the highest figure they may be required to pay,” says Heidbrink.

As a result, even a maximum payout would not overtax any individual insurance company. The worst case – a huge bomb in Frankfurt’s inner city – would cost Allianz or Munich Re at most €400m, thanks to their 16% share of Extremus’s €2.5bn cap. It is an amount that a company this size can muster without too much trouble.

So Leo Zagel and Gerhard Heidbrink can afford to be relaxed.