The threat of economic disruption to the global economy has never been greater than it is today. Countries and advanced economies the world over are facing threats on multiple fronts. From natural disasters that have arguably grown more erratic and frequent due to climate change, to the rise in cyber-attacks, terrorist activities and other man-made crises. These types of threats are harder to predict, and contain. Governments around the world try to prepare and build resiliency for these types of scenarios using a vast arsenal of tools, yet they still fall short. Time and time again, they fail to accurately account for the required monetary funds to properly mitigate, and respond to this new risk landscape.
It is hard for government agencies to properly anticipate the necessary funds to combat events that have no prior baseline. Predictive modeling can help governments determine what has happened in the past or what a likely event will cost in the future, yet allocating the required funds to properly mitigate these risks can prove futile and politically dangerous even though it is the prudent thing to do. In the U.S. budgetary process, if funds are not used, then their purpose is often questioned and future budgets may be reduced. The city of Washington D.C. recently suffered this type of unfunded loss by exhausting its $6mm snow removal budget when the city, along with much of the east coast, were hit with a major winter storm that dumped up to 40 inches of snow. This single event doubled the annual budget to $12mm. Even with the added funds, it still took weeks before all streets were plowed and individuals and businesses could return to normal. This took a major toll not only on the city’s budget, but the city’s overall GDP. This economic component is often lost on the general public when looking at these events, especially when taken in isolation. Finding ways to alleviate the costs and expedite the response process are paramount to keeping city economies flourishing without shouldering tax payers with unbudgeted debt
Lloyd’s, the world’s specialist insurance market, and Cambridge University recently launched the Lloyd’s City Risk Index 2015 -2025, taking an in-depth look at how both natural, man-made and emerging risks affect national GDP and economic resiliency. According to the City Risk Index, D.C. alone has an annual GDP at risk of $26.6bn due to various threats. When looked at on a broader national basis, the same City Risk Index study found that a cyber-attack on the U.S. power grid could cost upwards of $1 tn and leave 93 million in just New York and D.C. without power. With 15 suspected cyber-attacks on the U.S. electricity grid since 2000 according to the U.S. Department of Energy, the eventuality of this happening is becoming more and more likely. And yet, how is the government and private sector preparing to absorb these tremendous costs, and interruptions to the economy? The standard response is to equip government agencies such as FEMA or increase budgets, however, these methods repeatedly fall short and are among the costliest responses. These agencies are often underfunded for such catastrophic and unpredictable events, and budgets are often exhausted well before the perilous event takes place.
There are other solutions that have yet to be explored or fully developed which can address this pressing need. Once such solution is leveraging the insurance and capital markets for assistance. The global insurance market can offer support in terms of stop loss and reinsurance solutions, creating safety nets preventing allocating public funds from being depleted, or even transferring the risk entirely from the public balance sheet. This idea of putting a fixed price on uncertainly can help cities budget better and spend funds on other necessary programs rather than playing Russian roulette year after year. After all, long term investments in infrastructure or improving public education are just as important as subsidizing snow removal or hurricane cleanup efforts. The post-crisis expense, however, is often the one that gets financial support, but at great long term expense for national competitiveness. The same Lloyd’s City Risk Index research highlights how with just a mere 1% rise in insurance penetration, uninsured losses would drop by 13%, and taxpayer burden following a disaster would be further reduced by 22%. The broader use of insurance solutions would not just create a more resilient economy but it would lead to increased investments, equivalent to 2% of national GDP.
With this in mind, the question individuals would like ask is twofold: can the insurance markets bear these types of exposures, and are they willing to? The answer to both is a resounding yes. The non-life insurance markets have been experiencing steady growth and profitability over the last few years, with a 9 percent growth over 2015 alone, according to Swiss Re. In addition to this growth, several compounding factors such as increased M&A activity, market consolidation, improved technology, and new product innovations such as cyber insurance, have created large amounts of capacity and liquidity in the insurance markets. This excess capital is eager to be deployed and could be utilized as another method to help safeguard both private and public sector viability, while alleviating the burden on taxpayers. The insurance industry is also readily awaiting innovation in terms of technology, and product design. Tapping into new growth sectors is a sought after opportunity rather than cannibalizing existing commoditized programs. Markets like Lloyd’s are extremely malleable and with the right private sector partners, they are capable to design some of the most innovative insurance solutions on the planet.
The execution of such a plan is also feasible. Risk forecasting models, weather simulations, and a whole array of research tools are already being deployed by a multitude of government and risk industry experts, such as Resilient Solutions 21. This helps to identify the primary risk corridors and perils that need to be addressed. From flood zones and wildfires, to cyber threats and terrorist attacks, the insurance industry is set to provide support to transfer these risks off the government’s balance sheet. The way to approach these issues does not differ greatly from the way that insurers approach traditional risks. Looking at average snowfalls, rainstorms, and prior events certainly creates a baseline in some instances, but that alone cannot address the volatility and erratic nature of man-made events. Having a consortium of both private and public sector minds come together will be the key to developing sustainable solutions.
Many public leaders have already started to work hand in hand with private sector risk specialists to develop these very types of solutions that could save trillions in public sector losses and make for more resilient communities, cities and countries. Yet a very real challenge still remains in the bureaucratic process by which governments implement such progressive, public-private approaches. This will be the greatest risk that needs to be addressed to create effective change.