Compensation Against Terrorist Attacks

National Security Adds a New Policy Dimension

By Lloyd Dixon and Robert Reville

Lloyd Dixon is a senior economist at RAND. Robert Reville is director of the RAND Institute for Civil Justice, a unit of the RAND Corporation.

Lloyd Dixon
Robert Reville

In the wake of the devastating hurricanes that struck Florida, the nation’s compensation system kicked into high gear. Relief began flowing to individuals and businesses, much as it did in the aftermath of the 9/11 terrorist attacks. But while the players are the same — insurance companies, government agencies, the lawyers and courts of the tort system, and charities — the compensation issues for hurricanes and terrorist attacks, while similar in many respects, are fundamentally different in others.

During any disaster, the compensation system must deal with economic efficiency issues, for example, by providing incentives and the means to put idle assets and people back to work after a disaster. And in any disaster, the system must also deal with equity issues, whether by paying benefits to individuals and businesses that mirror their actual losses or by determining how benefits are distributed among possible claimants.

But unique to foreign terrorist attacks on our soil are issues of national security. The frequency and strength of hurricanes (or, for that matter, any natural disaster) are not affected by what we do to protect ourselves against them and recover from them. Not so with terrorists like al Qaeda, whose key goals are to induce panic, social fragmentation, uncertainty, and economic ripple effects. To the extent that the compensation policies we choose reduce those consequences, the policies will reduce the impact of terrorist attacks and, thus, may reduce the perceived payoffs to terrorists of carrying them out.

The policies we choose can make us more vulnerable to such attacks. In some cases, businesses may underprotect their assets. For example, a chemical plant may fail to secure dangerous chemicals from terrorists as thoroughly as society might desire because terrorists may be unlikely to use the chemicals against the plant itself. In such cases, it may make sense to provide adequate incentives for businesses to protect their assets by, say, having the government require minimum security measures.

In other cases, firms may go to the other extreme and overprotect their assets. As noted by RAND colleague Darius Lakdawalla, a business may decide to locate to a less urban area to reduce its exposure to terrorism. While such a response may make perfect sense for the firm, the remaining firms may face an increased risk of attack as a result. In these cases, it may make more sense to discourage businesses from investing in overly costly prevention measures or adopting socially undesirable avoidance measures by having the government subsidize terrorism insurance to cover potential losses.

While compensation systems must always deal with trade-offs between economic efficiency and equity, those trade-offs become more complicated when national security concerns enter the mix. For example, focusing on national security may result in lower economic growth if productive assets (such as high-rise buildings in New York City) are not built. Then again, compensation systems that focus on economic revitalization (for example, by encouraging large numbers of businesses and residents to return or relocate to Lower Manhattan) may have adverse national security ramifications by creating a target for terrorists.

National security concerns have not played a prominent role in developing or modifying policies on compensation and assistance in response to terrorism. Unfortunately, such thinking is only in the beginning stages. But as the nation begins to consider what to do next with its terrorism compensation policies — such as the Terrorism Risk Insurance Act of 2002 that expires in 2005 — it is critical that the national security factors be acknowledged in the debate. square