1 Research on National Security at the Wharton Risk Center Advisory Committee Meeting Wharton School University of Pennsylvania June 16, 2006

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3 A. Critical Infrastructure Protection CI: “services which are so vital that their incapacity or destruction would have a debilitating impact on the social and economic continuity of the country” (Transportation, Information and telecommunications, Water, Energy, Electricity, Public Health, Banking and Finance, Chemical Industry, Postal and Shipping, etc) B. Terrorism Risk Financing C. More Theoretical Research that Emerged from these Issues Complementary Fields of Research (ex ante/ex post)

4 A. Critical Infrastructure Protection (CIP) The private sector owns 85% of US CI Project 1 ( ) Analyze the trade-off private efficiency-public vulnerability in the context of CIP; focus on: vulnerabilities, resilience, interdependencies, competitiveness, information sharing, new security markets, national and international private-public collaborations. Joint research with Harvard and GMU Research output: several WP/publications; Seeds of Disaster, Roots of Response (Cambridge University Press) Project 2. Global supply chain security and impact of information sharing on risk sharing (Lockheed/DOT)

5 B. Terrorism Risk Financing Prior to September 11, 2001: terrorism included in all commercial coverage September 11, 2001: $35bn insured losses (2/3 paid by reinsurers, mainly European) Reinsurers stopped covering terrorism, insurers refused as well September 11, 2002: the US was largely uncovered Congress passed Terrorism Risk Insurance Act for 3 years ( ) – Covers up to $100bn Large uncertainty in 2005 as to whether TRIA will be renewed

6 B. Wharton Risk Center Initiative on Terrorism Risk Financing 10-month work (2005) A 9-person team; 3 departments Collaboration with a large number of organizations in the US and abroad Support document for Congress and other interested parties “One of the best studies on terrorism insurance and TRIA” The Economist, November 2005

7 C. More Theoretical Research (with a lot of practical implications …) Traditional assumption in the economic literature of risk financing/insurance: The insurer (the principal) proposes a series of contracts to insured (the agent), but is unable to observe perfectly the risk of its insured who can. Result: adverse selection (Rothschild/Stiglitz, 1976; Stiglitz, 1977) New Risk Center’s Working Paper shows: Problem: Growing empirical evidence there is NO adverse selection in many insurance markets: No positive correlation coverage/risk – There is even advantageous selection Research question: What would happen if the insurer knew the risks better? (reserved asymmetry) What would happen if the insured (a large company) had market/negotiation power?