European Union’s Democratic Deficit: A Critical Assessment

European Union’s Democratic Deficit: A Critical Assessment Introduction The European Union is in a middle of a crisis. The worst part of its economic crisis has passed but it still faces even more severe issue: a trust crisis. People do not feel represented by the European Union and have turned their support towards populist and radical movements. What is the basis of this crisis? Some authors incline to say it is the EU’s democratic deficit. Thus, since there is a wide gap between what EU citizens want from their politicians and how the EU bureaucrats and institutions act. This leads to a situation where the public’s opinion and desires are not taking into account by the body that should represent them[1]. Yet, first we need to analyse in detail what a democratic deficit means to then address this problem. Democratic deficit is a tricky issue as it does not have a widely accepted definition between politics and law scholars. Depending on the author and its background, the term can be used with different connotations and meanings; hence, the results of the analysis tend to depend on the notion of democratic deficit the author uses[2]. Therefore, first, we shall develop our own democratic deficit conceptual approximation. Then, we will be able to lead a critical assessment on representation and participatory actual problems of the European Union. Afterwards, we will have all the tools necessary to address in detail if there is a true democratic deficit problem in the European Union and to propose some possible alternatives to solve it. The European Union and Democratic Deficit If a hyperbole is permitted, democratic deficit may have as many meanings as authors have discussed it. It is not an easy issue to address or to encompass in a single-simple definition. First of all, especially because, even though we can agree on some basis for democracy, in wide terms it is an ambiguous subject. So, what an author considers a democratic deficit will be highly influenced by what he considers to be a democracy. One of the first scholars to use this term was British David Marquand. He used it to define the democratic legitimacy faintness of –then- European Community. He suggested direct elections for representatives before the European Parliament. When this was adopted, the issue around European Community democratic legitimacy arose even further, as for the European Parliament represented the voice of the European Community citizens but the Community was not ready to give more powers to the Parliament, causing more tension. After the approval of the Maastricht treaty, the problem grew. Two pillars were added to the Union (common Foreign and Security Policy and Home Affairs), and in none of them the Parliament had any control[3]. Other authors propose the democratic deficit problem in the terms of a backwards Hume’s is/ought as they consider there is a discrepancy between is and ought/ should in the European Union[4] institutions and democracy as the transfer of substantial amounts of political decision-making towards the supranational level on non-elected institutions has diminished the democratic influence and the basic control the citizens have on their political institutions. It is obvious that at the first stages of the European Community it was reasonable and necessary to keep citizens away from decision-making as it was initially designed to be an economic community and not a political institution[5], but its goals mutated in time. The Community passed from a purely economic institution to a political one. As it was a community formed by democratic countries, one could expect that the supranational body they formed would also have democratic and participatory channels. Nonetheless, European Union turned into a bureaucratic and political giant that has slowly diminished the national entities and directly-elected supranational bodies -European Parliament- and passed it to its hands. Yet, other approaches[6] suggest that, even though the democratic deficit issue is real, it has to be attributed to the Union’s member states, rather than the Union itself. Integration between European states was responding to a series of already-existing democratic legitimacy issues within the states. They argue that the Union is not democratic enough because the member states have not been able to democratise their integration. The issue of the lack of democracy within European Union institutions is not considered as the cause of the problem, but the natural consequence of the democratic deficit of European Union members. This perspective must be necessarily rebuked. Even with their flaws, most of the European Union members have developed and stable democracies. If an institution poses itself as the supranational ruler of a continent and its legitimate representative, it must follow the same form of government that those national units it intends to rule, which is democracy. Where could European Union legitimacy come if not from its citizens? The Union’s decisions directly impact its citizens, as much as a national government decision, or even more. It also breaks citizens’ capacity to rely on the regular channels of influence –voting- to ensure they are being listened and to participate in political process[7]. The lack of democracy of the Union and is tightness to evolve and accept citizens demands only causes further disgust and loss of legitimacy. European Union is a sui generis institution, as it is not a state but it represents them and takes decisions in their name, therefore it should be held accountable for its decisions in direct elections. One cannot fail to notice that there is a deep democratic deficit in the European Union from the turnout in its elections. Ever since legislative powers were transferred to the Council of Ministers of the European Union from the national governments, the setup of the European Union shifted from that of an economic block to that of a political one. The lack of democracy in the Union has been evident in the voter turnout. From the first vote in 1979, the turnout has been going lower and lower with the 2014 election having a disappointing turnout of 42.54%. Compared to the individual member nations where the average voter turnout is 68%, this is a sign that the members of the European Parliament have noted something wrong with the setup and are thus silently revolting. This has led to the debate as to what ought to be done to get the Union back on track. While one side states that reforms are enough to make the Union serve its needs, others think the European Union should be simply debunked. The fact that the European Union has a lot of benefits for its member states and the world in general, however, means that its abolishment is not the best solution. To get the best solution for the case, therefore, requires an in-depth analysis of how the Union works and where it is failing. The Origin of the Democratic Deficit of the European Union Looking at the origins of the European Union, it is easy to make the conclusion that it was primarily meant to be purely economic and the introduction of the political aspects only complicated issues. The Treaty of Paris in 1951 saw to the formation of the European Coal and Steel Community (ECSC) which was meant to provide a trading bloc for coal and steel in Europe as suggested by its name. In 1957, the Treaty of Rome saw to the establishment of the European Economic Community (EEC). The EEC’s original members were known as the European Communities. In 1993, the Maastricht Treaty would see to the establishment of the European Union. With the European Union came the introduction of European citizenship. The latest of the treaties in this regard is the 2009 Treaty of Lisbon. While a lot has changed in the structure and function of the European Union to the present moment, some of the problems that plague the Union are the same.   The Manifesto for the Young European Federalists by Richard Corbett first raised the issue of the lack of democracy in the European Union in 1977 where the term democratic deficit was first used. David Marquand would later use the term in reference to the workings of the European Economic Community. The coining of the term primarily focused on the European Parliament, which was previously referred to as the European Assembly, and why it had a deficit of democracy. The primary argument behind this assertion is that the Parliament was made up of members who had not been directly elected by the citizens of the European Union. As such, the European Union was not serving the needs of its citizens but those of a few people. Effectively, the European Union is thus not democratic enough given that it does not meet the definition of a democracy where there is a government for the majority. The fact that the majority is not represented through free and fair elections of the members of the European Parliament is one point to the fact that there is a deficiency of democracy in the Union. The European Constitution The European Union prides itself in democratic legitimacy through various aspects of the constitution. The first of these aspects is the European Parliament. The Parliament is subject to the electorates of the member states. The other organs are the Council of the European Union also called the Council of Ministers, and the European Council made up of the heads of national governments of the member states. The European Parliament and the Council of the European Union appoint the European Commission members. This system of making decisions is supposed to give the European Union democratic legitimacy in the same way the US House of Representatives and the US Senate give democratic legitimacy to the United States. Decisions are thus to be reached by both bodies agreeing, and a third organ in this case the European Commission. The intended democratic legitimacy has, however, not been entirely attained by the European Union. The construction of the Union itself has occasioned what the German Constitutional Court called a structural democratic deficit in the Union. This court established that the process of making decisions for the European Union was primarily those of an international organisation rather than those of a government. The difference is that, as an international organisation, the European Union based its democracy on the equality of the member nations rather than the citizens of these countries. It is thus difficult to reconcile the needs of the citizens and those of the member nations of the European Union provided its operation as an international organisation rather than a government. Similarly, the British Electoral Reform Society filed a report in 2014 to the same issue of the EU constitution having a structure which focused on the needs of the member states rather than the citizens. The r eport stated that, while the European Union has focused on upholding the principles of democratic engagement, accountability and representativeness, there is the need to focus on the needs of the minority in any democracy. The European Union, being mostly made up of minorities, thus needs to have a focus on serving the needs of the citizens rather than those of the member governments[8]. Democratic Deficit and the European Commission One of the main structures put in place by the European Union in support of democracy is the European Commission. First, there has been criticism concerning the legitimacy of the European Commission and its role in the initiation of legislation in the European Union. However, this criticism does not have the backing of facts as similar bodies within national governments have yielded similarly poor results. However, its position as a body that legitimises the European Union and its take on democracy has failed by a large extent. The main weakness with such a body, as also noted in the case of the United States government, is that the regulations may be so detailed that the member states have little freedom in making their decisions on legislation[9]. While the issue of a democratic deficit was noted as far back as the 1970s when the idea of a united Europe was still in development, democratic legitimacy has always been an issue the Union has been dealing with ever since. When the Treaty of Lisbon was put in place, its primary aim was to provide room for better democracy in the region. The Treaty of Lisbon required that the President of the European Commission ought to take account of the results of the European Union parliamentary elections. This simply means that the President of the European Commission should be nominated by the   most dominant group in the parliament. This step effectively makes the European Union a political body rather than the economic one meant for the over watch of the economic activities of Europe. In fact, the European Union, owing to this kind of structure, has become partly a federation and also an international organisation[10]. The President of the European Commission would thus be partly elected and partly appointed. This position gives the president less power than is needed to win the confidence of the population, and too much power to earn the trust of the governments of the member nations. The resulting model is one where little democracy is accorded to the citizens of the European Union and their governments as well. The European Parliament and Democratic Deficit When the European Parliament was set up, a lot of people were ready to voice its weaknesses in seeing to the implementation of legislation. However, political scientists would come to the rescue of this organ by stating that, first, the European Parliament is different from the parliaments of single countries due to various factors such as the lack of a divide between the government and the opposition, the presence of a divide between the executive and the legislature, the presence of political parties that are decentralised, bipartisan voting, and the roles of the various committees. For this reason, the European Parliament has been compared to the US House of Representatives but with the advantage of not having a governing body over it like the latter house. The fact that the majorities in the European Parliament have to be built each time while depending on negotiations, persuasions, and explanations ought to make it better in function than the US House of Representatives. This is true given that the lack of interference between the executive and the legislature has made the European Commission and the European Parliament more effective. For instance, the member states of the European Union have less than 15% of their legislative initiatives becoming the law. This is largely due to the lack of support from the executive. The executive bodies, on the other hand, rarely require the input of the legislature in the same nations to pass amendments. The role of the European Parliament is the propositioned amendments to the existing laws. The success rate of these amendments is as high as 80% with the lowest levels recorded (mostly for the hotly contested topics) is at 30%. To an extent, however, the structure of the European Parliament allows for a level of lack of accountability and weakness when it is compared to parliaments with an overwatch body like the case of the US House of Representatives. Voter Turnout in European Elections and the Impact on Democratic Deficit With any democracy, the legitimacy of the leaders in power heavily relies upon the turnout of the voters during elections. The European Parliament has had some of the lowest levels of elections voter turnout hence the reduction in its democratic legitimacy. This is based on the fact that the turnout of the European Parliament elections has been declining consistently since its formation. However, the President of the European Union, Pat Cox, said that the 1999 European Parliament elections and a far much better turnout than the presidential elections in the United States. Compared, the voter turnout for the presidential elections in the United States in 1996 was 49%. However, the voter turnout in the European Parliament elections for 1999 was at 49.51 percent. For both types of elections, this turnout was among the very lowest. While both are at their lowest, it is difficult to use this as an excuse for the lack of democracy in the European Union. As a matter of fact, the case of the United States is very different from that of the European Union and the reasons for the low voter turnouts. For the European Union, the people have an option of whether to belong to the Union or not. And the way they can show their willingness to belong or not belong to the Union is through participating (or not participating) in its activities such as elections. The social aspect of the European Union, that of being accepted or rejected by the people, has been observed in the way the people have turned out in low numbers at each European Parliament vote[11]. The massive lack of knowledge for the common citizen of the European Union has led to the lack of participation by the voters. On the other hand, the United States electorate can have a low voter turnout for many other reasons none (or very little) of which is being against the union that is the United States. As it is, the European Union is not a very effective and efficient democracy given that its workings are not in line even with the developing democracies of the world. First, it is torn between being a government, and an international organisation. Secondly, the citizens, having seen that the democracy of the Union does not work (and it is too complex to understand), are increasingly ceasing to buy into the idea of the European Union being there to improve their lives through fostering democracy. Democratic Deficit and the Council of the European Union Another organ of the European Union is the Council of the European Union. This Council is also part of the efforts of the union to foster democracy among the member states. Its primary role is acting as the voice of the member governments of the EU while adopting the laws European Union and coordinating the polices of the union as well. Depending on the policies of the union, the government ministers of the members states are the members or the Council of the European Union. The presidency of the Council is held on a rotating basis (among the states) with each president holding the office for 6 months only. The Council carries out voting on legislation and discussions with both exercises being held in public. The decisions are based on a qualified majority whereby at least 55% of the countries (which is about 65% of the total population of the European Union) are required. In blocking a decision, 4 nations are needed (being the equivalent of 35% of the European Union population). For issues that are of an administrative and procedural nature require a simple majority while a unanimous vote is needed for the very sensitive topics such as taxation and foreign policy. While the structure of the Council of the European Union seems to read democracy all through it, the same weaknesses that plague the European Parliament plague it hence it is just another example of democratic deficit in the EU. For one, own-initiative reports from either the European Parliament or the Council of the European Union do not have legal consequences as such to the member states. Also, both bodies cannot play major roles in the amendment and repealing of legislation that is already in place. Lastly, and most importantly, the bodies do not address the needs of the citizens of the member nations. Looking at the structure of the European Union, it is easy to conclude that the reason it has not met the needs of the citizens is because there is too much bureaucracy between the top organs of the Union and the common citizens for the member states. The organs are too separated from the citizens in that the decision made take a very long route to reach the citizen. The representatives also have to make decisions which serve the needs of the Union and those of their respective countries; an issue which often introduces a conflict of interest. What the European Union has Done to Better Democratic Legitimacy All the concerns expressed here about the democratic legitimacy of the European Union have been expressed before by various persons and bodies and they have been heard by the people at the helm of the Union. For this reason, the Union has put in place various changes to the constitution with the focus being on doing away with the noted weaknesses in the laws and constitution of the Union in general. Among the changes made include the introduction of the Maastricht Treaty. This was a landmark treaty which is credited with the introduction of citizenship of the European Union. This citizenship would grant EU citizens voting rights to the European Parliament in each of their countries. Even municipal elections of the European Union were also included in the treaty. The treaty would also introduce co-decision procedure in which the European Parliament was given powers that gave it an equal footing to the Council of the European Union in making legislative decisions[12]. These steps would make the European Parliament much more functional and powerful but not powerful enough to overcome the issues of being a purely democratic entity.   The other change made to the constitution of the European Union is the Treaty of Lisbon. Becoming effective from the 1st of December 2009, the treaty saw to better representation of the EU citizens both directly in the European Parliament and indirectly through the Council of the European Union. This was meant to foster democracy and representation. The treaty would also see to the implementation and acceptance of the co-decision procedure as the primary procedure for the legislative dealings of the Union. The Treaty of Lisbon is also credited with tremendously increasing the powers of the European Parliament by a large extent[13]. One of the main areas in which the Treaty of Lisbon helped focus on the EU citizens was in giving the citizens the right to make petitions to the European Parliament concerning any matters of material effect[14]. This increased the powers of the citizen and their levels of participating in the making of decisions. Further on, the treaty would ensure th at Council of the European Union meetings which discussed public matters are made public for all to see. In this way, the citizens can better understand the debates and the workings of the European Union. The Treaty of Lisbon also receives credit for improving on the role played by the national parliaments of the member nations in putting in place the laws and legislations of the Union[15]. Lastly, the Treaty of Lisbon is credited with giving the Charter of Fundamental Rights of the European Union full legal effect. This meant that various steps taken by the European Commission, the Council of the European Union, and the European Parliament would have full legal effect in areas where they apply[16]. Conclusion The workings of the European Union in seeking democracy have been so far ineffective on various levels as observed above. While there is intention from the leaders of the European Union to remedy these weaknesses in the workings of the Union, the fundamental reason why there have been low levels of success when it comes to attaining democracy for all citizens is its structure. It aims to operate like a government yet at its basic form it is an amalgamation of governments. Each of these governments have different needs, goals, histories and fundamental principles. The rest is that the leaders of each country first take care of their countries’ needs before those of the European Union. Also, its structure makes it difficult to make laws that will lead to better governance as each piece of legislation needs to have the needs of the many member states at heart. With time, it can be hoped that better legislation will be enabled for all the democracy to be attained. References Avbelj, M. 2005. Can the New European Constitution Remedy the EU Democratic Deficit?. EUMAP.org Campbell, M (2012) The Democratic Deficit of the European Union. Claremont-UC Undergraduate Research Conference on the European Union, p. 25. Castro, C. (2015). Assessing the Democratic Deficit in the EU: towards a Participatory Approach. RIPS, 14 (1), p. 63. Craig, P; Grainne De; P. P. Craig (2007). Chapter 11 Human rights in the EU. EU Law: Text, Cases and Materials (4th ed.). Oxford: Oxford University Press. p. 379. Dilek, K. (2011). The Problem of â€Å"Democratic Deficit† in the European Union. International Journal of Humanities and Social Science, 1 (5) p. 244. Electoral Reform Society — Close the Gap — Tackling Europes democratic deficit. European Parliament: Relations with National Parliaments. Innerarity, D (2015). The Inter-Democratic Deficit of the European Union: The Governance of Europes Economic, Political and Legal Transformation. Pp. 173-174. Kelemen, R. (2012). The Rules of Federalism: Institutions and Regulatory Politics in the EU and Beyond. Harvard University Press. pp. 21–22. Milev, M. (2004) A ‘Democratic Deficit’ in the European Union? Master Thesis, I.H.E.I. p. 10. Schà ¼tze, R (2012). European Constitutional Law. Cambridge University Press. p. 99. [1] Castro, C. (2015). Assessing the Democratic Deficit in the EU: towards a Participatory Approach. RIPS, 14 (1), p. 63. [2] Milev, M. (2004) A ‘Democratic Deficit’ in the European Union? Master Thesis, I.H.E.I. p. 10 [3] Milev (2004), pp. 11-12. [4] Dilek, K. (2011). The Problem of â€Å"Democratic Deficit† in the European Union. International Journal of Humanities and Social Science, 1 (5) p. 244 [5] Castro, C. (2005), p. 66. [6] Innerarity, D (2015). The Inter-Democratic Deficit of the European Union: The Governance of Europes Economic, Political and Legal Transformation. Pp. 173-174 [7] Campbell, M (2012) The Democratic Deficit of the European Union. Claremont-UC Undergraduate Research Conference on the European Union, p. 25. [8] Electoral Reform Society — Close the Gap — Tackling Europes democratic deficit. [9] Kelemen, R. (2012). The Rules of Federalism: Institutions and Regulatory Politics in the EU and Beyond. Harvard University Press. pp. 21–22. [10] Charlemagne. 2013. A democratic nightmare: Seeking to confront the rise of Eurosceptics and fill the democratic deficit. The Economist. [11] Avbelj, M. 2005. Can the New European Constitution Remedy the EU Democratic Deficit?. EUMAP.org [12] Schà ¼tze, R (2012). European Constitutional Law. Cambridge University Press. pp. 31–32. [13] Schà ¼tze, R (2012). European Constitutional Law. Cambridge University Press. pp. 43–44 [14] Schà ¼tze, R (2012). European Constitutional Law. Cambridge University Press. p. 99. [15] European Parliament: Relations with National Parliaments. [16] Craig, P; Grainne De Burca; P. P. Craig (2007). Chapter 11 Human rights in the EU. EU Law: Text, Cases and Materials (4th ed.). Oxford: Oxford University Press. p. 379.

Compulsory Education Essay

Many may argue education is at its finest since things seem to get better with time; but is this the case when speaking of compulsory education? Compulsory education in the United States today has come a long way from original ideas concerning education. There are some satisfied with the way schools are constructed; yet there are others who are not. Much like anything else, compulsory education can be improved. According to Paul Goodman, requiring students to attain two years for maturing between high school and college can improve compulsory education (Goodman 2012). The history of compulsory education dates back to before the medieval era. As one may guess, compulsory education has been changed drastically since it was introduced. By the year 1918 all of the United States and territories had laws governing compulsory school attendance. Executing compulsory schooling allowed a more productive means of solidifying national school attendance. At this time, compulsory education is a form of progress setting the stage for more jurisdictions in state legislation regarding these attendance policies (Richardson 1994). Compulsory education has significant advantages and disadvantages. Compulsory education has great effects on enforcing children to go to school. Sadly enough, not all families want their children to go to school or be educated beyond a certain point; or for that matter, some children do not desire to continue their education. Fortunately, these attendance policies make children attend school up to a certain point, which depends on the state. The major disadvantage of compulsory education is that not everyone is â€Å"classroom material†. Some people prefer a being employed and establishing a steady income at an early age rather than going to school. A prime example of this is about a teenage boy, Charlie, was bored with school so he started skipping class for weeks at a time. Even then, Charlie proved to be successful in the landscaping business despite the substantial amount of time he lost in school (Inson 2006). Whether the effects of compulsory education are essential to one’s success or not, it plays a key role in today’s schools. Like anything else, compulsory education can and should be refined and enriched. Some of these ideas of improvement are shared by many but have not yet been enforced. The government should be more responsible for setting goals within the system and providing the infrastructure to do so. Also, the government should be responsible for analyzing the outcomes from students once these provisions are set (Yasuhiko 2005). Going further as to say, raising the age of compulsory education, which is an idea shared by many. This enforces students to continue their education for longer periods of time, which in turn, would ultimately provide more productive citizens to the American society (NASSP 2010). Certainly, compulsory education is a significant part of the history and present day schools. Education is everything in today’s society. There are immense advantages as well as disadvantages concerning this subject. Compulsory education is essential to schools in the United States and will continue to be. Continuous reform and amendments will be made along with new laws and policies governing compulsory education and attendance. Learning is a ceaseless process. Works Cited National Education at the Beginning of 2001. â€Å"Innovations and Developments in Education System†. 2002. Richardson, John G. â€Å"Compulsory School Attendance†. 1994. Inson, Peter. â€Å"The Guardian†. November 2006. Yasuhiko, Torii. â€Å"Redesigning Compulsory Education†. October 2005. < http://www. mext. go. jp/b_menu/shingi/chukyo/chukyo0/toushin/06051511. pdf>

Automated Highway System

As described and depicted in Sci-fi futuristic films like I, Robot, Minority Report and Star Wars, the Automated Highway System (AHS) features an automatically controlled transportation system that is meticulously interlaced with the highway system.   The principal idea of AHS is to remove the driving operation from human control and assign it to the vehicle, which in turn collaborates with the highway system to perform such function.Thus, the concept of AHS involves technology that can be classified into three groups namely, intelligent technology on board the vehicle, intelligent technology in the road, and communication technologies that link or connect the vehicles to road.   Communication facilitates interactivity and information exchange between vehicle and highway infrastructure and action is undertaken by user/ vehicle in an automated fashion.   (Ioannou, p183)AHS technology for vehicle auto-control accentuates on how automobiles can routinely detect road driving barrie rs especially other vehicles, the track course, traffic management rules, as well as internal engine problems so that the vehicle can instinctively make the proper steering, turning, braking, lane changing, stopping and other related movements involved in driving.The current trend under this heading is the blending of car and computer technology.   On-board PC promises latent flexible innovations which include internet communications, car operation (sound, air-conditioning and navigating through voice) and paging, etc. (The Economist)Current technology leading towards this end includes the intelligent cruise control system which use radar or laser to sense vehicles along its driving path that commands vehicle to decelerate or accelerate as needed or allowed; the driver status monitoring which reveals driver status i.e. consciousness levels, stare direction, driving skill, etc. in another vehicle to warn other drivers on the road; collision notification that forewarns or notifies d rivers for potential crash or collision accidents with other cars; navigation assistance systems such as traffic and traveler information and on board diagnostics system that detects potential vehicle malfunction in advance, among others. (Cheon)AHS technology for highway control include traffic monitoring for traffic management, highway and incident surveillance technologies of which there are intrusive (pneumatic road tube, inductive loop detectors, piezoelectric sensors, magnetic sensors and weight in motion) and non intrusive technologies (video image processor, microwave radar, infrared, ultrasonic and passive acoustic array sensors (Vehicle Detector Clearing House), and lane tracking and positioning, among others.Finally, technology for the seamless communication of the vehicle and road infrastructure is necessary for the integration, collaboration and connectivity of the system’s operations. The focus of research on communications technology is the improvement in the p rovision of real time, reliable data communications among vehicles and between vehicles and highway infrastructure.The global positioning system (GPS) is a promising technology for transportation communications for the fulfillment of AHS. It utilizes satellites rotating around the earth that pick up radio signals from users to calculate and determine their exact position including latitude, longitude and altitude. (Helms)The multifaceted potential benefits of AHS to the ordinary citizens, the transportation sector, and the general economy are both vast and profound. By removing the human component in driving and its penchant to errors, driving safety will be significantly improved. Factors such as fog, darkness and other severe weather conditions that can disturb visibility and directly impact driving performance can be eliminated.Since driving is automated, it affords people free time for productive activities during travel such as studying and reading as well as leisure for playin g, sleeping or relaxing.     For the elderly, the disabled and other people who do not know how to drive, driving skill is no more a hindrance to travel and mobility.   Ã‚  Ã‚  Travel time is also expected to be reduced because of free flow travel conditions as the traffic management system will control and balance the speed of cars depending on the congestion of highway used at that time. (Ferlis)

September 11 Insurance Industry Finance Essay - Free Essay Example

Sample details Pages: 21 Words: 6152 Downloads: 1 Date added: 2017/06/26 Category Finance Essay Type Argumentative essay Level High school Did you like this example? Sept. 11 attacks exposed insurance industry to new and unheard costs of global terrorism. Terrorist attacks on Sept. Don’t waste time! Our writers will create an original "September 11 Insurance Industry Finance Essay" essay for you Create order 11 were the most expensive insurance event in history till that date. Sept. 11 attacks cost about $40 billion to the insurance industry (Hartwig, 2002). The previous biggest single event insurance loss was $19 billion for Hurricane Andrew (Hartwig, 2002). Insurance losses from Sep 11 attacks are almost double the losses from any event before that. The most significant aspect of this huge insurance loss was that insurance companies paid claims for an event that wasnt even properly priced in premiums. Terrorism related insurance was covered but not clearly defined and demarcated in insurance policies. â€Å"The unthinkable was insured† said Mr. Leidthe (Williams, 2002). The extent of Sept. 11 losses has changed the risk profile of insurance industry dramatically. Lloyds Chairman S. Riley said â€Å"In a world post September 11, when the very nature of risk has so fundamentally altered..† (Lloyds, 2001). Extent of insurance losses Sept. 11 attacks cost about $40 bil lion to the insurance industry (Hartwig, 2002). The majority of losses were borne by the non-life insurers with life insurers paying about $2.7 billion only. Though life insurance loss is not significant as that of non-life insurance, yet it was substantial figure in itself and by far the highest single event life insurance loss till date. The table 1 below shows the line of business losses for Sep 11 attacks. The highest single line loss was suffered for business interruption and its share of total losses was 27 percent. The combined loss suffered by property line was 24 percent. Table 1 Line business losses for the insurance industry $ billion Insurance Losses % Property WTC 1 2 3.5 9% Property Other 6.0 15% Business Interruption 11.0 27% Life 2.7 7% Workers compensation 2.0 5% Aviation 4.0 10% Other 11.0 27% Total 40.2 100% (Source: Insurance Information Institute, 2002a) The losses incurred by the insurance industry were unprecedented in many aspects. It was the largest single event insurance loss both in terms of natural and man-made disasters till that date. It was also the first time when losses were catastrophic in life insurance, disability and worker compensation insurance sectors. It was also the largest loss for the aviation insurance. Insurance industry had previously also faced terror losses. The table 2 below lists the major terrorist attack losses in past. The previous highest insured property loss in any terrorist loss was $907 million for a bomb explosion near NatWest tower in London in 1993. The insured property loss in Sep 11 attacks was $20 billion, about 22 times more than the highest previous loss. This huge increase in losses caught most of the insurers unaware and presented a scenario which was not modelled before. Table 2 Major terrorist attack losses Date Description Losses * $ Millions Sep 11, 2001 9/11 attacks 20,300 April 24, 1993 Bomb near NatWest tower in London 907 June 15, 1996 IRA bomb near Manchester Mall 744 February 26, 1993 Bomb in WTC Garage 725 April 10, 1992 Bomb in London Financial District 671 * Insured property loss Adjusted to 2001 price level (Source: Insurance Information Institute, 2002a) Sept. 11 terrorist attacks also showed the global integration of insurance industry. More than half of the final payouts were from non-US companies (Williams, 2002). Though this caused wide spread losses across borders, yet it also prevented more bankruptcies. The industry has learnt a lesson from this and now more insurers and re-insurers are forming pools to underwrite insurance. Insurance industry reaction Industry wide big changes in insurance sector normally occur at the time of some catastrophic events and losses. After Hurricane Andrew in 1992, insurers started charging high premiums in coastal zones and require special windstorm deductions. The post Sept. 11 insurance industry changes are similar to post Hurricane Andrew changes. Insurance industry has taken many steps to reduce potential losses. The first step was to raise premiums. The post Sept. 11 insurance premiums were much higher and it was not unusual to see premiums ranging from 7 percent to 10 percent of the stated value of coverage in the beginning of 2002 (Hartwig, 2002). Lloyds of London are now offering premiums ranging form 1 percent to 5 percent of the limit value (Hartwig, 2002). The price may fall further in future as the capacity in the insurance sector increases. The average increase in insurance premium was around 30 percent by the second half of 2002. The increase was caused by both reduction in capital supply and higher demand of insurance in light of increasing dangers. With the passage of time, the rise in premiums has slowed down again as more and more capital flows in the insurance industry and creates higher competition. The reduction in reserves post Sept. 11 coupled with regulatory capital requirement took many insurers and re-insurers to the capital markets. Insurance industry had raised total capital of $28 billion by June 2002 (Hartwig, 2002). Even though premiums will fall, it is unlikely that the coverage off ered will match pre Sept. 11 coverage. Airline industry was one of the hardest hit by the increase in insurance premiums. Coupled with high losses due to flight cancellations, it approached governments to bail it out. Many governments offered terror risk insurance to airlines. The increase in premiums has reduced the combined ratios to almost the lowest levels seen in the decade before Sept. 11 attacks. It reduces the reliance of insurers on investment income. The industry has seen that low investment returns and high terror losses can occur at the same time and hence it would be naà ¯ve to rely on investment returns to offset underwriting losses. The key lessons learnt by the insurance industry from Sept. 11 attacks are: Insurers are aware of larger potential losses Amount of risk capital required to support insurance is very high Reduced capacity results in supply versus demand pressures Insurance industry should not base its model on investment returns compensating underwriting losses The remaining part of the paper looks at the effects of Sept. 11 attacks on the insurance industry. Section II looks at the short term effects and section III studies the medium to long term effects. The paper concludes with section IV. SECTION II SHORT TERM EFFECTS Insurance industry had to immediately rise to the occasion which was not even properly thought also. Its short term reactions were key to the stability of financial industry. The following are the main short term effects of the Sept. 11 attacks on the insurance industry Ability to pay The attacks were the big test of global insurance industry and demonstrated the financial strength of the insurance industry. In spite of the negative returns from stock markets in 2000 and 2001, insurance industry has managed to pay insurance claims associated with Sept. 11 terrorist attacks. A major factor in that is the spread of payments over time. According to a study by A. T. Kearney, only about 15 percent of total claims were settled in 2001 and about 50 percent of claims were to be settled in 2002 and 2003. The remaining 35 percent of claims were to be settled in 2004 and beyond because of the nature of losses related to injury and pollution. The above spread of payouts means that insurers had to pay approx. $6 billion only in 2001, an amount absorbed by the insurance industry without much of financial damage. The primary insurers and re-insurers raised their premiums immediately after Sept. 11 and that will absorb or even exceed Sept. 11 attacks payout in remaining years. Only one re-insurer, Japanese re-insurer Taisei Fire and Marine, had to file for bankruptcy due to its high exposure in the aviation insurance sector. Ichiro Ozawa, the president of now bankrupt Japanese re-insurer Taisei Fire and Marine said that the loss from reinsurance was caused purely by the terrorist attacks and they could not foresee that such a huge loss would be generated because the four airplanes simultaneously crashed (BBC, 2001). Its position was further financially weakened by the Nov 12, 2001 crash of an American Airlines flight. Another re-insurer Copenhagen Re stopped accepting new business after Sep 11 attacks. But no primary insurer filed for bankruptcy. Another reason for insurance industrys ability to pay huge claims was the wide spread of risk among a large number of insurers and re-insurers. Till July 2002, a total of 119 insurers worldwide had announced their exposure to the Sept. 11 attacks (Hartwig, 2002). Widespread use of re-insurance was the key i n preventing large number of insolvencies. The table 3 below shows the estimated insurance losses related to Sept. 11 attacks in July 2002. The largest share of single insurer, Lloyds of London was only 7 percent. This shows the spread of insurance risks and the prominent reason behind just one bankruptcy due to Sept. 11 attacks. Table 3 Estimated losses of major re-insurers $ millions Estimated losses % of total losses Total losses 40,200 100% Lloyd of Londons 2,913 7% Munich Re 2,442 6% Swiss Re 2,316 6% Berkshire Hathaway 2,275 6% Allianz 1,323 3% (Source: Hartwig, 2002) The insurance industry ability to pay claims strengthened investors faith in it and helped the industry to raise further capital. Underwriting losses Prior to Sept. 11, insurance companies were earning overall profits mostly through returns on investments. But the two years of equity market losses in 2000 and 2001 forced insurance companies to re-look at their business strategy. The magnitude of Sept. 11 losses meant that equity returns werent enough to give overall positive profits. Insurance companies were forced to abandon the practice of accepting losses on underwriting business in the hope of covering loss by high investment returns. This means that insurers had to increase premiums to reduce dependence on investment returns. Price of insurance premiums Primary insurers and re-insurers have hiked their premiums since Sept. 11 terrorist attacks (General Accounting Office). The table 4 below shows the increase in insurance premiums across different lines of business in the first half of 2002. Table 4 Increase in insurance premiums in the first half of 2002 0% 1-10% 10-20% 20-30% 30-50% 50-100% 100% Workers Compensation 5 % 13 % 19 % 32 % 15 % 5 % 2 % General Liability 2 % 9 % 24 % 45 % 15 % 2 % 1 % Commercial Umbrella 2 % 4 % 10 % 20 % 27 % 17 % 16 % Commercial Property 3 % 4 % 16 % 30 % 31 % 13 % 1 % Business Interruption 3 % 8 % 32 % 33 % 10 % 1 % 0 % (Source: Hartwig, 2002) We can see that the percentage of no increases in insurance premiums for all lines is only in single digits. The median increase range is between 20 percent to 30 percent. Both commercial umbrella and commercial property insurance lines have similar percentages in 20-30 percent and 30-50 percent range which implies that mean for these insurance lines would be more than 30 percent most likely. In case of commercial umbrella, there were 16 percent insurers who increased the premiums in the first half of 2002 by more than 100 percent. In US, insurance premiums were already rising in 2000. General Accounting Office of US said that insurance premiums were already increasing for commercial coverage prior to Sept. 11 (General Accounting Office). It also said that insurance industry members told it that the increases were a part of the underwriting cycle normal. Yet the GAO acknowledges that the insurance losses from Sept. 11 terrorist attack almost certainly exacerbated the rise in premiums. Net written premiums rose by 5.1 percent in 2001 (Insurance Information Institute, 2000b). The increase in the insurance premium was a result of both decrease in supply and increase in demand. Decrease in supply capital. The high abnormal losses sustained due to Sep 11 attacks reduced the capacity available to the insurance industry for writing new business. Another factor contributing to the reduction of capital was the decline in equity markets. Equity markets were on a decline since March 2000 and as insurance companies invest a large part of their free cash in equities, it meant that they needed more reserves to offset losses suffered in the equity markets. Lower amount of capital meant that insurers could choose the policies and / or markets offering high insurance premiums. Increase in demand. The scale of losses from Sep 11 attacks again brought back the attention to the scale of risk businesses carried and the necessity of a mechanism to offset it. Well diversified companies in terms of geographical reach like British Petroleum have the option of â€Å"self-insurance†. BP decided based on the wide spread geographical spread of its business units and plants that an attack or a loss of a single location would not jeopardise the whole business. It is also unlikely that more than one location will face catastrophic disaster at the same time. Hence BP took the decision of not paying high insurance premiums every year. But less diversified businesses dont have this option. The terrorist attacks increased the demand of insurance policies from businesses. The fear of the loss increases demand and London insurers Catlin and Hiscox have predicted that the Katrina hurricane in USA would boost insurance demand and rates (Slater, 2005). Lloyds and other insurers predict t hat the Katrina hurricane would cause heavy losses but would be beneficial in the longer term as it will push prices for affected risks steeply up. At the same time there is some rationale justifying increase in insurance premiums. Insurance premiums normally follow cyclical trends based upon the capacity and willingness of primary and re-insurers to take risk. Prior to Sept. 11 attacks, the insurance premium rates had peaked in 1993 and since then they were on constant decline (OECD, 2002). The rates had only stabilised in 1999 and started moving up in 2000 only. Even after one year of premium increases since Sept. 11 attacks, the insurance premiums are still lower than the peaks seen in 1993. Underwriting losses Since 1975 till 2001, insurance industry had underwriting gains in only two years and that too in as early as 1977 and 1978. Since 1978 the insurance industry had consistently made underwriting losses and they were about $30 billion in 2000 also (Insurance Information Institute, 2002a). The increase in insurance premiums would reduce underwriting losses. Combined ratio The combined ratio for US reinsurance sector was highest and worst ever in 2001. It was 142.9 percent in 2001 and next highest ratio was 126.5 percent in 1992. This shows the extent of losses due to Sept. 11 attacks (Insurance Information Institute, 2002a). The combined ratio for Lloyds reinsurance in 2001 was 142 percent (Lloyds, 2001). The combined ratio was 116 percent for all lines combined ratio. The combined ratio for all lines combined was also highest in 2001 but the next high was 115.8 percent in 1992 (Insurance Information Institute, 2002a). So the impact on all lines combined ratio was not as bad as on re-insurers. High premiums post Sept. 11 attacks resulted in one of the lowest combined ratio in 2002. The combined ratio for the US reinsurance was 102.3 percent in the first quarter of 2002 and it was very close to the lowest of 100.5 achieved in the past one decade (Insurance Information Institute, 2002a). For all US lines combined, the ratio at 101.6 percent was the lowest in last one decade. This shows that the increase in premiums has significantly increased the profitability of insurance industry. Coverage The unprecedented high losses stemming from Sept. 11 attacks forced insurers to re-look at the range of risks covered. Another major post Sept. 11 step was the reduction of coverage offered by the insurance companies. Mr. Hess of Swiss Re said in 2002 that Swiss Re had cut its potential exposure to less than half for events similar to attack on World Trade Centres (Williams, 2002). Patrick Liedthe, Secretary General of the Geneva Association also reiterated the above point and said that the exposure of the global industry to terrorist attacks is much lower post Sept. 11 attacks (Williams, 2002). Terrorism exclusion One of the most significant policy changes in the post Sept. 11 insurance sector is the introduction of terrorism exclusion from general insurance policies. Insurance industry was covering terrorism related risks even after the first attacks on World Trade Centres in 1993 and Oklahoma City bombing in 1995. The fact that the risk was covered for very little or no prem ium immediately forced most of the insurers to exclude acts of terrorism from general insurance coverage. The other alternatives to terrorism exclusion were either to stop writing new business in soft target industries like commercial landmarks, chemical and power plants etc or to charge steep premiums to take care of more frequent terrorist attacks. The absence of statistically significant data hindered the quick development of rationally justified terrorism risk pricing. If insurers stop writing new business because of terrorism risk then it would expose businesses to financial risk from so many other events like fire, floods, etc. So it was better to exclude terrorism risk in the immediate aftermath rather than pricing irrationally or stop writing new business. After initial withdrawal period of terrorist related insurance, private insurance market again saw insurance products for these types of major attacks (OECD, 2002). Some of the insurance instruments like catastrophic bonds already existed in the private market even before Sept. 11 attacks. Catastrophic bonds are not actively traded and are mainly used for special events rather than being available for general use. The reluctance of insurers to cover terrorism insurance and the high premiums charged by many insurance companies has left many companies with no terrorism cover. In July 2002, about half of the businesses were not covered by terrorism cover at all (Hartwig, 2002). Only 14 percent of businesses had full coverage. This shows that only a minority of businesses are fully prepared to face terror risks. Even though most of the companies dont have self-insurance luxury that can be afforded by big multinationals like BP, they are not prepared to pay high insurance premiums to safeguard their business against terror attacks. Insurance Information Institute has a Rate On Line index which correlates the link between price of insurance and the limits of risk offered. The Rate On Line was 1 30 in 2001 and it increased to 215 in 2002 after steep increase in premiums and reduced limits (Insurance Information Institute, 2002a). Rebuild reserves. The high abnormal losses of Sept. 11 attacks resulted in $80 billion reduction in insurance industrys ability to meet future insurance claims (Williams, 2002). The reduced capital base and increase reserve requirement to handle equity losses mean that many companies were either unable to take any further shocks or had to raise further funds to strengthen their capital base. Many companies raised additional capital to meet regulatory capital requirements. By the end of 2001, insurers had raised $20 billion in new capital (Hartwig, 2002). And by June 2002, the total capital raised increased to $28 billion. The pace of capital raising slowed down significantly thereafter as the reserves rose due to higher premiums. It is hard to categorise the amount of capital raised separately into terrorism related insurance and other insurance lines. They thing important here is to note that Sept. 11 attacks acted as a catalyst for fund raising. Role of government As a result of complexity in pricing terrorist risks and associated high losses, many insurance firms withdrew risk coverage of terrorist attacks. This left many firms, vulnerable to such attacks, exposed to huge losses in case of terrorist attacks. US government then promulgated Terrorism Risk Insurance Act 2002 to cover major terrorist risks. Aviation insurance We now look at the aviation insurance industry, one of the two main insurance sectors affected by the Sept. 11 attacks. It was the first sector to react and it is a general belief that post Sept. 11 knee jerk reaction of the aviation insurance sector was an act of over reaction. Giles Williams of Wills Global Aviation said that the industry over reacted and it shouldnt expect profits in the year of its biggest loss (Shapiro, 2002). Aviation insurance sector lost $5.5 billion in 2001, out of which $3.97 billion was related to Sept. 11 attacks alone (Shapiro, 2002). The high loss prompted aviation insurers to not only swiftly raise premiums after the attacks but also impose new surcharges. Aviation insurers started charging $1.25 per passenger surcharge to replenish premiums. The increased premium and new surcharge increased insurance premium income by almost three folds in 2002. Aviation insurance premium totalled around $4 billion in 2001 as compared to around $1.2 billion in 2000 (Shapiro, 2002). Aviation insurers justified the increase by saying that the industry had suffered on average $1.7 billion loss each year between 1992 and 2000 (Shapiro, 2002). In addition to that insurers have to pay about $1.5 billion in administration, re-insurance and higher retention of primary insurers. One change welcomed by the airline industry is the better rationale for pricing. Previously aviation underwriters traditionally calculated liability premium by the kilometres travelled by the airplane. Indirect effect of insurance industry on non-insurance industries Sept. 11 attacks were probably the first insurance related event that had an impact beyond the directly related insurance sectors. It was expected that the attacks would lead to increase in premium for commercial property and airline insurance sectors. But the attacks put the focus on all sectors / industries that are thought to be soft targets for terrorist attacks. The rise in insurance risk premiums were more in line with their risk profile than any other factor. Natural terrorist attacks prone industries such as shipping, tourism and energy generation plants have faced some of the highest increases in insurance premiums. Commercial property and liability insurance rose by about 30 percent on average in one year after Sept. 11 attacks (OECD, 2002). â€Å"Target† structures those whose destruction can cause multiplier effect such as chemical and power plants and high rise office buildings saw even steeper increases. One thing to note is that the increase in premium s came after decade of decline. Even though the premiums have increased considerable the average insurance premium is still lower than the peaks seen in the decade before Sept. 11 attacks. Though the average insurance premium may still be lower than the levels seen in 1993, the insurance premium rates for â€Å"target† industries have risen sharply and hence the rise might be skewed too unfavourably for them. Reduced insurance coverage may hinder the availability of sufficient financial instruments to cover risks associated with terrorism. Lower investment and capital expenditure may have a negative impact on economy. Insurance industry took many steps immediately to correct the situation caused by the Sept. 11 attacks. We saw above that insurance premiums were raised, risks covered were reduced and many companies partially or fully withdrew from the terror risk insurance market. The above immediate steps did help the insurance industry to increase capital and profit ability in the short term. But the question looming is whether the insurance industry would be able to continue taking steps to maintain or increase its profitability. And how the short term steps would fare in medium or long term. SECTION III MEDIUM TO LONG TERM EFFECTS We now look at the medium to long term effects of the Sept. 11 attacks. The major effects are: Price of insurance premiums Post September 11, the net premiums in the US reinsurance industry increased by 14.1 percent in 2002, a rate of growth not seen since 1986 (Insurance Information Institute, 2002b). Lloyds mentioned in its 2001 Global Results pointed that early 2002 is seeing significant improvement in business conditions caused by higher demand and increased prices (Lloyds, 2001). The cost of insurance price dropped significantly in 1990s. The cost of risk to business dropped by 42 percent between 1992 and 2000 (Hartwig, 2002). If we add in the affect of inflation, the real drop in insurance premium would be much more. So sooner or later the insurance premiums had to increase. Insurance premiums also had to rise due to increasing medical and legal costs. The steep rise in insurance premiums attracted more capital to the insurance sector. In its Global Results for 2001, Lloyds pointed out that the inflow of capital, especially in Bermuda would slow down the increase in insurance premiums (Lloy ds, 2001). It is difficult to escape the cyclical nature of insurance sector. Increased capital will again increase competition leading to renewed price competition in the medium term. General Accounting Office of US government also pointed out that while there may be some examples of excessive price increases in the market, as long as insurance continues to be available, it is likely that competitive pressures will ultimately remedy that problem (General Accounting Office). Lloyds and US General Accounting Offices assessment of medium term slower growth in insurance premiums was correct. The US property and casualty insurance industrys net written premium growth was only 4.7 percent in 2004 as compared to 9.8 percent in 2003 (Insurance Information Institute, 2004). Pricing of terrorist attacks In Sept. 11 attacks, insurers lost heavily on life, building and airplane insurance at three different places including one for two World Trade Centre towers. It is extremely difficult to price the probability of multiple occurrences for such events. But we are seeing more of such events and it was demonstrated again in July 7, 2005 when four near simultaneous terrorist attacks shook Londons underground and bus network. It is difficult to price risks related to terrorism. Several factors contribute to this pricing conundrum. First, terrorist attacks are very less in numbers as compared to the frequency of other insured losses. So there is lack of sufficient data to model insurance premiums. Second important thing is the possibility of many catastrophic events occurring at the same time. Since Sept. 11 attacks, world has seen many more terrorist attacks. Though the losses suffered there are not significant to the scale of Sept. 11 destruction, yet the insurance industry is mor e aware of the scale of losses. The slowdown in insurance premium growth indicates that the insurance industry is now pricing terror risk more rationally. Coverage In a study conducted by Joint Economic Committee of Congress, US on terrorism insurance, the major finding was the limited market for terrorism related insurance post Sept. 11. Re-insurers started excluding terrorism from insurance policies in the beginning of Jan 2002. With no government assistance, primary insurers were forced to exclude terrorism related coverage from insurance policies too. US government soon introduced Terrorism Act of 2002 to act as insurer of last resort. Since then many primary insurers have re-started offering terrorism insurance. But the market is not as wide and deep as it was before Sept. 11 attacks. As re-insurers first excluded terrorism cover, primary insurers limited the coverage. Initial coverage was limited to at most $150 million. The coverage was also subject to higher deductible. Over time the limit has increased but it is no where near the previous coverage levels. Also some companies are not writing terror insurance policies. Even the o nes who are writing terror policies are defining limits properly. It is unlikely the commercial property and casualty insurance will ever get the same terror risk as was there before Sept. 11 attacks. Increased risk at primary insurers level The higher reinsurance costs have lead many primary insurers to retain higher amounts as reinsurance at lower levels is now too high and economically unviable. Primary insurers are still writing terror risk insurance policies but not taking reinsurance as the costs of high reinsurance dont justify taking them. They also want to keep higher proportion of insurance premiums with them to pay for terror attacks. But not taking reinsurance has left them exposed to high costs if any major terror attacks take place. There is a possibility of failure of such primary re-insurers. Capacity The capacity of the insurance industry is limited and as it has been demonstrated by the Sept. 11 attacks, the terrorism related losses could easily run into anything catastrophic. The insurance industry has managed to survive Sept. 11 attacks without much financial jitters. But a few more attacks of such scale can easily push a large number of insurers into bankruptcy. This will have an irreparable damage on not only the financial health of insurance industry but also on the general economy and growth. In June 2001, the aggregate claims paying ability of the property and casualty insurance industry was about $300 billion. The Sep 11 property and casualty losses are about 10 percent of the claim paying ability. Though the claims are to be paid over time, yet the payout represent a significant part of the claim paying ability. We should also exclude some categories like auto and home from the total property and casualty claim paying ability as the attacks targets were mainly comm ercial property. The surplus claim paying ability of the related insurance sectors was just $100 billion before Sept. 11 and fell to $80 billion after the attacks (Hartwig, 2002). The limited coverage with restrictive terms along with withdrawal of insurers from many markets meant that the insurance industry lost another $40 billion or so in capacity (Hartwig, 2002). The introduction of Terror Act 2002 by the US government increased investors confidence in the insurance industry. The bill brought back many insurers and hence increased the capacity. The increase in capacity slowed down the increase in insurance premiums. Market perception Stock markets are a good indicator of things to come. Fear of high Sept. 11 related claims led to dumping of insurance shares in the week after the Sept. 11 attacks. The insurance company shares fell by about 10 percent in the first week of trading after Sept. 11 attacks (Hartwig, 2002). Investors were also concerned about the possibility of more such large scale attacks. Warren Buffet mentioned that any nuclear attack by terrorists can wipe out the whole insurance industry (Hartwig, 2002). But the initial negative sentiment towards insurance shares soon reversed into a positive outlook. The sharp increase in premiums made investors take a re-look at the medium and long term profitability of the insurance industry. The positive outlook was also strengthened by the fact that only one re-insurer filed for bankruptcy. Investors also woke up to the idea of reducing exposure and tightening underwriting standards by the insurance industry. Who wouldnt like to invest in an industry which is increasing the price of its products yet at the same time offering less to its customers. It is a double win situation. Role of government Sept. 11 attack has also established a closer relationship between the insurance industry and governments. The US Senate passed the Terrorism Risk Insurance Act of 2002 on June 18, 2002. The US President signed the bill on Nov 26, 2002. The insurance act is about sharing of terrorism related insurance losses between insurers and the government. The insurance industry was asked to retain certain amounts to meet terrorism related claims. The government was acting as re-insurer of last resort and agreed to pay 80 percent to 90 percent of the losses based on the amount of losses. The US government also capped its liability on all cases to $100 billion. The initial sharing agreement is for three years and the government will then review the extension at that stage. US governments intervention to take risk previously insured by the private sector was intended to be a short to medium term step. It was a step taken to restore public confidence in business. It appears that the knee je rk reaction of aviation insurers in increasing premiums has driven business out and brought government in. As aviation insurance sector had made losses in 8 out of 10 years prior to 2001, it was probably not the right insurance sector for private companies. Or is the government entry as insurer of last resort in US was inevitable? Airline industry was already reeling under heavy losses due to post Sep 11 flight cancellations, lower ticket sales and general poor state of economy. The high increase in premium made it very difficult for them to survive. US based airlines have formed Equitime, a company incorporated to cover war and terrorism risks. Over time it is expected to build a capacity of $1.5 billion to provide coverage for war and terrorism risks. The US federal government will act as the insurer of last resort. US government helped in setting up of Equitime by guaranteeing its role as insurer of last resort. Prior to that, the US government had little or no role in priv ate insurance market. But the governments across the world, especially in developed countries, have been acting as re-insurer of last resort. And these are the countries who have seen terrorism related violence in the past. UK had been facing IRA related terrorist attacks for decades. To take into account the potential of very high losses the government set up Pool Reinsurance. Under this scheme, there is limited private cover with additional excess cover for both property damage and business interruption made available for companies who join Pool Re. The UK government acts as re-insurer of last resort in case of insolvency. In Israel, terrorism risk is excluded from standard policies. Israeli government covers terrorism related property damage losses. Post Sep 11 attacks, France and Germany have also set up state sponsored re-insurers for terrorism related risks. In case of France, the membership of this re-insurer is compulsory for all members of French insurers associati on. The UK government also extended the terrorism insurance cover for commercial property in 2002. The increased threat and frequency of big terrorist attacks makes it very difficult for private insurers to cover all terrorism risks and governments entry either as a re-insurer of last resort or pool provider was inevitable. Alan Greenspan said to the Joint Economic Committee of US Congress that in situations of violence, the viability of free markets may require that the costs of insurance are borne by the taxpayer (Hartwig, 2002). So what was initially thought to be short or a medium term measure would probably become permanent. It is very difficult for governments to withdraw support. Since many other nations have not withdrawn such facility, US government would also keep it. Effect on small businesses The smaller firms are also feeling the post Sept 11 insurance changes. In UK, The Federation of Small Business has warned that soaring insurance costs of obligatory employers liability insurance premiums are forcing many small firms out of business. Small firms dont have negotiating power and are often squeezed by their bigger customers. They survive many times on tight margins and increase in insurance premiums may just be the tipping point for some to close business (Madslien, 2002) Insurance industry took immediate steps after Sept. 11 attacks to maintain its financial health. Many of those steps have medium to long term effects on insurance industry. The industry has been plagued by cyclical nature of high and low insurance premiums and low and high combined ratios. The premiums increased after Sept. 11. But the rate of growth has slowed down in the last year. The insurance industry target of around 90 percent combined ratio is still some distance but if it keeps increasing premium rates, even at a low rate, it might reach there. The only thorn in that achievement would be the industry itself, where low combined ratios pull in more capacity and higher competition lowers insurance premiums. SECTION IV CONCLUSION Sept. 11, 2001 attacks were the biggest terrorist attacks ever and exposed insurance industry to man made catastrophic losses. Terrorist attacks on Sept. 11 cost about $40 billion to the insurance industry and are almost double the losses from any event before that. Insurance industry though covered terror risk yet it wasnt either priced or was priced very less in the premiums. The loss faced by the commercial property insurance industry was about $10 billion and so was the loss in the business interruption line. Yet the insurance industry survived bankruptcies and assured the world of its ability to pay claims. This was due to the global nature of re-insurance industry and sharing of risks. Now more insurers and re-insurers are formi ng pools to underwrite insurance. The industry took quick steps of limiting or withdrawing terror cover. It is not easy to price terror and the easiest way out was to stop terror cover. This left many businesses exposed to high risk of terror. Over time more insurers have started offering terror cover but have limited their scope of losses. This is one of the major impact of Sept. 11 attacks and it is unlikely that the insurance industry will ever offer pre Sept. 11 terror cover. It also increased premiums to make up the losses in the next few years. The increase was about 30 percent on average across most of insurance lines of business. The premiums have been increasing since then and have resulted in some of the lowest combined ratios in the last 15 years. But the lure of higher premiums has brought in more capacity into the insurance market. This has again increased competition and led to lower growth in insurance premiums. Insurance industry should try not to again fall in to cyclical trend of high and low premiums. It should learn the lesson now of now basing its model on investment returns compensating underwriting losses. Back to: Custom Essays BIBLIOGRAPHY AND REFERENCES BBC (2001). â€Å"Japanese insurers reel†, https://news.bbc.co.uk/1/hi/business/1669703.stm General Accounting Office. https://www.gao.gov/new.items/d02472t.pdf Hartwig, R.P. (2002). â€Å"One Hundred Minutes of Terror that Changed the Global Insurance Industry Forever†, Insurance Information Institute Insurance Information Institute (2000). â€Å"2000 Year End Results†, Insurance Information Institute, https://www.iii.org/media/industry/financials/2000yearend/ Insurance Information Institute (2002a). â€Å"The Long Shadow of September 11 Impact Implication for Insurers and Reinsurers†, Insurance Information Institute, www2.iii.org/media/presentations/sept11/ Insurance Information Institute (2002b). â€Å"2002 Year End Results†, Insurance Information Institute, https://www.iii.org/media/industry/financials/2002yearend/ Insurance Information Institute (2004). â€Å"2004 Year End Resultsâ₠¬ , Insurance Information Institute, https://www.iii.org/media/industry/financials/2004yearend/ Lloyds (2001). Global Results, 2001, https://www.lloyds.com/index.asp?ItemId=2416 Madslien, J. (2002). BBC. https://news.bbc.co.uk/1/hi/in_depth/world/2002/september_11_one_year_on/2207645.stm OECD (2002). â€Å"Economic Consequences of Terrorism†, www.oecd.org/dataoecd/11/60/1935314.pdf Shapiro, S. (2002). â€Å"Aviation markets Sept. 11 response debated†, Business Insurance, Chicago, Aug 5, 2002, Vol. 36 Slater, S. (2005). â€Å"Catlin and Hiscox see Katrina loss but rates boost†, www.reuters.co.uk, 12 September 2005 Williams, F. (2002). â€Å"Attacks force insurers to rethink strategy†, www.ft.com, Sep 10, 2002 More Free Finance Essays Get free finance essays from our extensive online resource library. Hundreds of example essays available from all the major essay topics to help you with your research Please note: The above essay was written by a student and then submitted to us to display and help others. Thanks to all the students who have submitted work to us.