VIII. Shall We Overcome?
How can we direct our resources in smarter ways to meet our security challenges and at the same time bring our fears back to a “normal” level?
GDP@Risk and the City Risk Index: An Example of a More Sober Approach to Resilience in the Face of Real Future Risks
While cities in developed economies often groan under the strain of congestion, they are generally orderly places with vibrant economic activity. By contrast, cities in emerging economies often struggle to supply basic services to their densely-packed inhabitants and even basic infrastructure, such as roads, utilities and other public works struggle to keep pace with demand. This strain is projected to grow exponentially through 2030, where our relentless drive towards urbanization will see no less than 41 megacities around the world—each home to more than 10 million people. Of these, 90 percent will be in developing and emerging countries. Large cities with 5 to 10 million inhabitants will continue to proliferate, tilting the scale of not only urbanization, but market demand away from advanced economies. While urbanization will continue to strain resources, it will also be the crucible in which human ingenuity builds a more resilient future. This resilience depends on enduring public-sector leadership combined with market-driven private sector solutions. As seen at the conclusion of climate talks in Paris, COP21, a rare act of unanimity among the world’s political leaders, people are recognizing the urgent need for greater resilience. Different from risk, resilience is something we must pay for in advance, rather than treat like an economic surprise. For this resilience dividend to be cashed, people must first invest in overcoming their fears.
Cities in the Crosshairs
An in-depth analysis of 18 city-level threats recently carried out by Cambridge on behalf of Lloyd’s, led to the City Risk Index. Globally the chief peril identified in this research is economic risk resulting from an interconnected, high-speed global economy. Beyond economic shocks, like those still reverberating from the 2008 crisis (aka the Great Deleveraging), other threats are beginning to surface with increasing frequency. Cambridge researchers coined the term GDP@Risk to capture the share of economic value at risk should any one of the 18 threats emerge in a particular city. Similar to the concept of value at risk (VaR) seen in banking, this metric reduces often complex and amorphous “not in my lifetime” risks to an understandable measure of what economic value is at stake. Beyond measuring economic losses should a certain threat emerge, GDP@Risk establishes a benchmark for what type of capital reserves may be required of the system in order to create more resilience.
The 18 threats identified in the City Risk Index fall into three categories—natural, man-made, and emerging risks. Overall, the Index offers a taxonomy of how to think about emerging threats. Of these, climate change emerges as a real and present danger. From hurricane Katrina, which inundated New Orleans, to the first ever smog red alert that shutdown Beijing, city managers need more and more to respond to natural events exacerbated by man that are out of our control. Record snowfall in Boston exceeding 108 inches in the winter of 2014, for example, brought this usually winter-ready city to its knees. On September 27, 2015 Paris halted all vehicle traffic in the city due to a lingering high level of air pollution. Some city-level events occur because of under-investment in infrastructure, as we saw in the 2003 blackout, which was the largest such event in North America and triggered by accident.
Looking at the 35 North American cities in the City Risk Index, the top five threats were market crash, oil price shock, cyber-attack, flood and human pandemic. Taken together the index estimated that $616 billion in GDP would be imperiled. It is characteristic of these types of complex risks that they often interact with one another. For example, a terrorist attack or cyber warfare against critical financial systems can trigger economic shock, just as natural hazards can have spillover effects into other domains. Moreover, the threats highlighted in the Index should be thought of as being both acute and attritional in nature—some sudden catastrophes are the result of long slow-burn phenomena. The complexity of these emerging threats, along with others that are not in the Index, such as war, requires the development of new solutions to increase resilience. Through a patchwork of resilient cities, a resilient country and in turn a more resilient world can emerge.
A Roadmap to Resilience
Of the risks threatening North American cities and, indeed, cities in diverse regions of the world, the majority fall into the man-made domain. Man-made risks contribute 62 percent of the GDP@Risk in North America, and nearly 50% of the risk contribution for the 301 cities in the Index. This confirms that the twenty-first century is in every way the era of man-made risk.
Looking at the United States, for example, the challenge is our national readiness in the face of critical risks. However, the last decade of partisanship has reduced the impetus for a national consensus on how (and whether) to respond to a changing world—let alone act with the type of leadership these emerging threats require. Instead, power and the ability to respond to risk has in many ways devolved to the state and city level, where individual roadmaps to resilience are being charted.
Resilience is an outcome not an aspiration. A critical first step is recognizing real risks, and separating them from ephemeral ones. Second it requires concerted action to build redundancy in critical systems, while at the same time building the financial reserves to absorb shocks. Insurance has an unglamorous but crucial role to play. Lloyd’s research found that a 1 percent rise in insurance penetration corresponds to a 22 percent decrease in the financial burden passed on to taxpayers following a loss. Once an insurer’s reserves are exhausted, a rare but not unlikely event, the next tier of liquidity in heavily regulated financial markets like the United States are the state insurance guarantees. These funds are pooled in each state and generally administered by state-level insurance regulators. Looking at the types of city-level threats highlighted in the City Risk Index, the liquidity of state insurance guarantees would quickly evaporate, as would have been the case in post-Katrina New Orleans had federal assistance not been granted. While solutions exist to harness the capital markets in response to catastrophic losses, such as catastrophe bonds, these instruments are generally attached to single risk domains, such as wind storms, and not a broad basket of city-level perils.
From cyber risk to climate change, building resilience in our more complex world will require more innovations in the science and technology of risk analysis as much as policy changes and the choices individuals make. More cities with cyclists, for example, translates into lower CO2 emissions and faster egress from a city under threat. The City Risk Index is a call for greater integration of financial solutions, of which insurance is a part, along with better and more sophisticated analysis of what is at stake.