Embracing a changing risk landscape
On the one hand, societies and working processes are becoming increasingly digital and therefore more vulnerable to a loss or misuse of data. At the same time, climate change is altering the occurrence, severity and frequency of natural catastrophes. Both trends will require a response from the insurance sector to adapt coverage accordingly.
Some cities are more exposed to these trends than others, as the recent Lloyd’s City Risk Index shows. The index measures the potential risk from 22 threats to the economy of 279 cities across the world. In 2050, an estimated 66 percent of the global population will be urban residents. Cities are the key drivers of national and global prosperity, accounting for 80 percent of global gross domestic product (GDP). However, while this brings great efficiencies, as people and assets concentrate in urban centres, they become increasingly vulnerable to risk events, the report suggests.
Intangible risks are on the rise
One important factor increasing the vulnerability of urban populations is the fast progress of digitisation. While increasing efficiency, digital processes make societies and economies more vulnerable to disruption due to system failure or cyber-attacks.
This in turn will drive a need to better protect intangible assets, including supply chain disruption and reputational damage.
“The City Risk Index shows that man-made risks such as cyber are having an increasingly large economic impact compared to natural catastrophes".
“The research results indicate the changing nature of risk from tangible to intangible risks,” says Flemmich Webb, Senior Manager, Strategic Communications at Lloyd’s. The current ratio is around 15 percent tangible to 85 percent intangible, he notes.
“The trend towards intangible risk is driven, for example, by the growth of the Internet of Things (IoT) with connected devices and vehicles generating sensitive data which needs to be collected and stored and is at risk of being lost or compromised,” Webb adds.
Other Lloyd’s research shows that a cyber-incident that takes a top-three cloud provider offline in the US for three to six days would result in an estimated economic loss of between $6.9 billion and $14.7 billion, and between $1.5 billion and $2.8 billion in insured losses.
The growing cyber threat is one of a number of man-made risks on the increase including major accidents, terrorism or the consequences of a market crash to the economy.
“The City Risk Index shows that man-made risks such as cyber are having an increasingly large economic impact compared to natural catastrophes,” Webb says.
Man-made threats currently account for 59 percent of the total $546.50 billion at risk across all the cities and threats included in the research report. At this point, cyber is seventh in the ranking of the top threats which are part of the report.
The costliest threats
The most costly threat in the Index globally is market crash with an estimated cost of $103.33 billion on an annual basis, followed by international conflict with $80 billion. The next highest are tropical windstorm ($62.59 billion), human pandemic (47.13 billion), flood (42.91 billion) and civil conflict ($37.15 billion).
While risks posed by man-made threats may increase due to urbanisation and digitisation, natural catastrophes are also expected to become more frequent and severe due to climate change. Climate-related risks account for $122.98 billion of GDP under threat, according to the report.
“Climate change is expected to result in higher losses from natural catastrophe events such as heatwaves, droughts or flooding and change the geography of risk,” Webb says.
In 2018, Cape Town became the first modern city to consider turning off the water distribution because its water supply failed, but it is unlikely to be the last. Other cities, including Beijing, London and Sao Paulo, also face the challenge of drought.
Climate events such as temperate and tropical windstorms could impact GDP globally by $66.31 billion every year and flood is set to account for $42.91 billion to the total of $122.98 billion for climate events, the Index finds.
Climate change is likely to increase further the burden on Asia, which is already the region with most GDP at risk worldwide. Currently, Asian cities stand to lose the most GDP to risk, accounting for $241.28 billion or 44 percent of the global total, with tropical windstorm the costliest single risk at $60 billion. Asia’s prominence in the index reflects the emergence of several of its cities as economic powerhouses.
Allied to their exposure to natural threats, which accounts for more than half of their total GDP at risk, this means the region stands to lose more than others, the Index suggests.
In comparison, North American cities can expect to lose $92.96 billion each year and European cities, $70.33 billion. In both regions, market crash is the single costliest risk. Cities in the Middle East and Africa may lose $97.20 billion of their GDP in total, with interstate conflict the costliest risk. Latin American cities make up less than 10 percent of the global total, with $44.73 billion of GDP at risk.
The cities most at risk
Of the cities included in the Index, Tokyo has the most economic output (gross domestic product, GDP) at risk with $24.31 billion at threat from various rarely occurring threats such as earthquakes, or from more frequently occurring events such as cyber-attacks. However, the leading threat for Japan’s capital is interstate conflict, according to the research. Japan is, for example involved in territorial disputes with China and Russia, and faces the ongoing spectre of North Korean nuclearisation.
The city that stands to lose the second most GDP annually is New York ($14.83 billion, where the main threat is from a market crash); followed by Manila ($13.27 billion, tropical windstorm) and Taipei ($12.88 billion, tropical windstorm) in the ranking of the most at risk cities. Other cities high on the list include Istanbul (interstate conflict), Osaka (interstate conflict), Los Angeles (flood), Shanghai (tropical windstorm) and London (market crash).
Part of the solution to mitigating these risk exposures is risk transfer via insurance as it can provide a much-needed cash injection following a catastrophic event, allowing cities to rebuild and recover more quickly, and reducing the impact on the economies.
The onus in this fast-changing risk landscape then is on insurers and brokers to invest in developing new products, particularly relating to man-made risks which are difficult to quantify in terms of both probability and scale, as the Index points out.
Products have been developed to cover political risk and cyber-crime, and the industry has a good track record in providing cover for high impact risks such as terrorism and nuclear accident, the Index notes.
More needs to be done
“The insurance industry could do a better job in promoting the essential role it plays in reducing risks and in helping companies and communities recover post disaster.
To do this effectively especially in the man-made risk space, it must work with businesses and governments to share data,” Webb says.
“Technology can also play a huge role to help assess risk areas, damage and claims, and insurers are working hard to adopt new systems and processes to improve customer service,” he explains.
While no city can be completely risk free, active risk management can minimise the effect on GDP. However, when it comes to climate change, many cities lack the financial capacity to protect themselves. In order to address this issue, the G7 Initiative on Climate Risk Insurance agreed to increase access to direct or indirect insurance coverage against the impacts of climate change for up to 400 million of the most vulnerable people in developing countries by 2020. The overall objective of the initiative is to stimulate the creation of effective climate risk insurance markets and the smart use of insurance-related schemes for people and risk-prone assets in developing countries.
As part of the Paris Agreement, a legally binding global climate deal reached in December 2015, 195 countries acknowledged the need to cooperate and enhance the understanding, action and support in different areas such as early warning systems, emergency preparedness and risk insurance.
If every city in the world were to improve its resilience to “very strong”, this would reduce global GDP at risk by $73.4 billion, the Index suggests. London and Paris are addressing challenges relating to ageing infrastructure, whilst cities in Latin America, Africa and Asia must keep up with the impact of population increases that are putting stress on existing systems. There is also scope for more innovation in infrastructural design. More than half of the world’s future urban spaces are yet to be built, so there is an opportunity to build new cities which are highly resilient to both the pressures of urbanisation and a changing climate. Indeed, it is hoped that these emerging cities will blaze a trail that all the cities included in the Index can follow.
“We need all parties to contribute to this process,” says Webb. “Governments, Insurers and businesses should work together to strengthen global resilience”.