Natural catastrophes have always shaped the course of human history, and even the most terrible recent disasters often have well-documented historical antecedents.
Yet even with historical context, risk is on the rise, driven by a confluence of factors—including a changing climate, the rise of urbanization and the mega city (particularly in the developing world), and the integration of our global economy through ever-more optimized and fragile supply chains.
Our global society is increasingly vulnerable to volatile natural hazards, with enough feedback loops and butterfly effects to make even the most ardent complexity theorists’ heads spin with the dystopian possibilities for our planet.
When my co-founder and I started Risk Management Solutions (RMS), we had earthquake-modeling software for three cities in California. Today, RMS models catastrophic risk in more than 90 countries, including earthquakes, hurricanes, floods, terrorism, and pandemic diseases. Our little team of five back in 1989 now numbers more than 1,200.
We are a commercial business, and most of our clients are insurers, reinsurers, and specialist investors in the capital markets. Yet from day one, I’ve been motivated by a “big ideal”: By quantifying catastrophe risk, we can help society better manage risk, and make the world a safer and more resilient place.
Scientific and objective measurement of risk enables the market mechanisms needed to insure, hedge, manage, and ultimately mitigate these risks. Also, the robust availability of catastrophic insurance creates the right incentives to drive risk management behavior, enabling more-rapid recovery following a disaster and leading to more resilient societies.
I got a chance to put this thesis to the test in the aftermath of Superstorm Sandy. One of the many dramatic consequences of the storm was the damage to the New York City subway system, which suffered extensive flooding throughout. With our help, the New York Metropolitan Transit Agency (MTA) turned to the capital markets to place an innovative “catastrophe bond.” Using our models, we crafted a first-of-its-kind parametric index that would trigger if storm flooding reached certain levels, as measured by tidal gauges around New York City. The MTA successfully issued $200 million of these bonds under the name MetroCat Re and will have three years of protection against storm surge.
I found it particularly encouraging that part of the reason the investors were so supportive of this deal was because it had positive social impact. They felt that they were helping protect a valuable public good—and as a result, “leaned into” the deal.
Whether we are talking about strategies to mitigate catastrophe risk or the cost-benefit of climate adaptation, it’s very difficult to argue the uncertainties of future benefits against the here-and-now costs of action.
Former Secretary-General of the United Nations Kofi Annan put his finger on the challenge during a speech in 1999, saying, “Building a culture of prevention is not easy. While the costs of prevention have to be paid in the present, its benefits lie in a distant future. Moreover, the benefits are not tangible; they are the disasters that did not happen.”
The asymmetry of the debate can lead to paralysis. Yet by developing systematic methods to quantify catastrophic risk, we can measure and then monetize—through insurance and reinsurance markets—both the consequences of the status quo and the benefits of mitigation or adaptive strategies.
Insurance and its relatives in the reinsurance and capital markets may not be the most glamorous of industries, but it has a long and honorable tradition of providing protection, monetizing risk, and creating the right incentives for mitigation that ultimately leads to reduced risk for the betterment of society. It wasn’t that long ago, for example, when cities in the United States and Europe used to catch fire on an alarmingly frequent basis; insurers and reinsurers helped reduce risk by linking coverage to incentives, which helped foster better building codes and fire protection practices.
While insurers don’t always get it right, many people in civil society and public policy circles view market forces as part of the problem. To make change happen, we need a harmonization of rigorous science and modeling to define the risk, robust global insurance and reinsurance industries to create sustainable incentives for mitigation, and public policy strategies that harness these forces rather than thwart them.
There are signs of progress. A recent article in the New York Times Magazine, “Mutually Insured Destruction” called out the unique role that insurers and reinsurers can play. More provocatively, Goldman Sachs just identified the changes in how the insurance and reinsurance industries manage catastrophe risk as one of the “The 8 Extraordinary Technologies Forcing Businesses to Adapt or Die.”