New Opportunities for Investors Willing to Embrace the “Resilience Gap”
Daniel StanderApril 12, 2018
This is a reprint of a “Trading Room” interview from Trading Risk magazine, please click here to visit the magazine website.
Opportunities abound for investors willing to embrace the resilience gap, according to RMS global managing director Daniel Stander
How does the Protection Gap offer opportunities for investors?
I’m afraid you’ve pushed one of my buttons with your very first question! I’ve been trying (unsuccessfully it seems) to move the debate away from the “protection gap”. I much prefer to talk about the “resilience gap”. This isn’t me being a pedant. The language we use here is important. Framing the problem in terms of “protection” grounds the debate in risk-transfer solutions.
But we all know that risk capital alone cannot address the fact that communities all over the world are frequently brought to their knees by the impacts of extreme events. Risk financing is no silver bullet. Those at risk — from the individual homeowner to the elected official governing a sovereign state — need much more than just contingent capital to materially increase their resilience to acute shocks. They need to develop a deeper understanding of the risks they face — and how it compares to their desired ability to withstand extremes.
More than that, they need to understand what interventions offer an acceptable ROI — from enforcing building codes to preserving nature-based defenses. And then of course they need to be prepared to respond effectively when the ground shakes or the wind blows, lest the economic impacts escalate. Opportunities abound for investors – but they will only be seized by those who can embrace the totality of the “resilience gap” and position their risk capital in the totality of the need.
What new innovations are on the horizon?
Innovations come when sellers find new ways to profitably help buyers solve their problems. When it comes to insurance-linked securities (ILS), experience has taught me that models make markets. Why? Well, market demand for an emerging type of coverage is often left unmet because the capital cannot be deployed with sufficient confidence.
The right analytics remove enough of that uncertainty to enable buyers and sellers to meet. It’s no coincidence, for example, that surge risk had never been securitized until RMS released a storm surge model. So, you ask me where I see innovation coming. Many of the answers can be found in our product road map: flood, cyber, marine, liability — a suite of high-definition models which will enable innovations in ILS.
What scope is there for the establishment of social development ILS funds?
We are increasingly involved in discussions as to the societal benefit of parametric ILS. There is a lot of innovation afoot, especially in terms of linking risk financing to investments in risk reduction. These conversations are increasingly joined up, involving fund managers, end investors, donor governments, recipient nations and venture philanthropists. I don’t think it will be long before we see an ILS impact fund set up that is motivated less by profit and more by a desire to increase the resilience of less developed communities.
Where is the role for ILS in international development?
Disasters in developing countries roll back years of hard-won economic gains. Parametric ILS can support the recovery efforts with rapid and transparent access to large pools of capital in the aftermath of disaster. But this is just one of the tools available. ILS must be considered alongside investments in disaster preparedness, risk mitigation, such as resilient building practices, and other financing instruments. 2017 highlighted that natural disasters can cause losses which dwarf a country’s entire GDP.
View of damage caused by Hurricane Irma in Road Town, the capital of the British Virgin Islands, taken on September 13, 2017. Image credit: Flickr/DFID – Russell Watkins
Against this backdrop, Lloyd’s and RMS have partnered with the U.K. government Department for International Development, to explore the potential for innovative financial products to incentivize resilience. Could parametric products help get core services like education and health up and running more quickly? Would having cover in place build institutional capability around risk management? Can risk transfer incentivize better building practices? There’s still much to be done, but these ongoing efforts can only accelerate the development of a viable, resilience-linked product.
Why were RMS annual average losses reduced ahead of the active hurricane season?
The medium-term rate (MTR) is a regionalized average for the next five years. It looks at the impact of projected sea-surface temperatures (SSTs) in order to determine where along the coastline, and at what strength, hurricanes are likely make landfall. The 2017 MTR stated a) that there would be fewer hurricanes, and b) that the energy provided by warm SSTs may lead to stronger-than-average hurricanes that drive tail risk. So, the 2017 North Atlantic hurricane season largely fitted with our model.
The MTR is grounded in objective science. We follow a systematic process each time we update it. We analyze 13 different statistical models, which all provide a five-year forecast of activity for the Atlantic basin, and we take a weighted average across these models based on their relative “skill”. The most statistically skillful of these models identified a shift to a future period of below-average hurricane activity, in part based on the 2012-16 decrease in Atlantic Basin major hurricanes.
What keeps you up at night?
I’m often asked this. People seem to assume that I lie awake at night fretting over all the really bad things that could befall humankind. The reality, however, is that working at RMS affords a better-than-average sense of perspective, especially when it comes to the probabilities of nasty extremes.
In fact, I’m often struck by how influenced people are by the latest news headline. This week might all be about cyberterrorism. Next week it’s an outbreak of a lethal virus. And the week after it’s earthquake risk. The truth is, the relativity between the frequency/severity distributions of different potential shocks is pretty constant. That’s arguably one of the virtues of a stochastic approach: a long-term view that helps keep things in perspective — during the day and at bedtime!
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A postcard from Manila…
Situation: rapid, uncontrolled urbanization and limited enforcement of building codes.
Complication: unwieldy administrative procedures, limited funding, a lack of technical expertise and #NIMTOO.
Result: an alarming rise of building vulnerability in hazard-prone communities putting millions of low-income people at extreme risk.
While many local government officials recognize this problem, progress is painfully slow. Housing vulnerability continues to rise. What to do?
The Issue of Our Age?
According to my favorite bricklayer, Dr. Elizabeth Hausler, housing vulnerability is the defining issue of our age. By 2030, three billion people will live in substandard homes. That’s one third of the world’s population.
Just ask Santiago Uribe Rocha, the first Chief Resilience Officer employed in a non-OECD country. In Colombia over the past 20 years, more than ten million people have moved to major cities like his, Medellín. The lack of affordable housing has led many of these low-income families to settle on the outskirts, often building haphazardly with poor quality material.
According to CENAC (Centro de Estudios de la Construcción y el Desarrollo Urbano y Regional), three out of every five new homes built in Colombia today are of “informal origin”. In other words, 60 percent live in homes that are built without any legal procedures or formal design process.
Despite acknowledging the issue, city governments often lack the means to effectively deal with increasingly vulnerable housing stock. Cumbersome bureaucracies complicate matters. In some neighborhoods, city officials require over six months to approve the retrofit of a single home.
The result: hundreds of thousands of low-income families remain significantly at risk of death, injury and destitution in an earthquake.
Change Is Building
RMS has been working closely with Build Change since 2013. By sharing research, expertise and resources, we’ve been supporting the non-profit’s preventive programs in Latin America, the Caribbean, Nepal and, most recently, Southeast Asia.
The partnership, focused on promoting the benefits of retrofitting homes for low-income families living in informal neighborhoods, is closely aligned with RMS’ overarching, societal purpose. After all, for the last 30 years, RMS’ mission has remained the same: to make communities more resilient through a deeper understanding of the impacts of extremes.
With RMS’ support, Build Change has been able to develop the basis for successful retrofit projects. Shared value abounds…
The local governments have been convinced to effect and enforce changes to urban planning and building ordinances.
The local construction industry has been upskilled and employed.
The local insurers are finding new opportunities to offer affordable policies.
The local residents now have disaster-resilient homes and insurance coverage.
Quantifying Resilience; Increasing Institutional Urgency
Catastrophe risk models have been vital to this process. By combining science, technology, engineering and data to simulate the potential impacts of future disasters, RMS modeling puts a number on the potential impacts of “informal” housing. Moreover, the models can be used to evaluate how risk might reduce if mitigating measures are put in place.
A virtuous circle often results: quantifying the value of building practices drives funding; funding helps protect more communities; more communities protected demonstrates the value of resilient building practices; more funding follows.
For example, in 2016 RMS quantified the cost-effectiveness of a proposal for a scaled retrofit program in Bogotá, Colombia. Preliminary analysis showed that over 120,000 deaths and US$2.8 billion could be avoided in a 1-in-200-year event by retrofitting homes in the five neighborhoods studied.
RMS and Build Change also demonstrated that the project would deliver an attractive return on investment. Analysis showed that the retrofits could be completed using existing local skills, with minimal training, and for less than half the price of demolishing to rebuild.
In this case, the modeled output did not just increase the institutional urgency to deal with the problem of vulnerable housing. The analytics also contributed to the wider acceptance in Colombia of retrofitting as a viable solution.
Now What?
In approximately five years of formal partnership, RMS and Build Change have collaborated to greatly improve the safety of seismically-vulnerable communities. By combining our risk modeling expertise and institutional support with Build Change’s technical knowledge and grass roots approach, we’ve not only demonstrated that retrofitting in vulnerable neighborhoods is possible. We’ve also shown it’s a cost-effective way to save lives and livelihoods.
As a result, the Government of Colombia recently made the retrofitting of 600,000 homes an urgent, national priority.
Of course, our work in Latin America is by no means done. And collaborations with Build Change continue in Haiti and Nepal as well.
Immediate attention, however, has shifted to the Philippines. It’s too early to judge the outcomes. But with 69 million low-income people living in 15.6 million vulnerable homes today, the potential to make a difference is huge.
By quantifying that potential, we hope to develop a compelling business case to address what is arguably the issue of our age. By putting a number on the resilience dividend, we hope to attract the #ResilienceFinance needed to make some of the world’s most densely populate cities significantly safer.…
Almost one and a half million people have died in natural disasters over the past 20 years. This is a waste of life; a waste of potential.
Natural disasters also have a massive economic impact. Our models suggest natural catastrophes cost the world’s poorest countries almost US$30 billion a year on average. Hard-won development gains are regularly wiped out — and it is the poor and the vulnerable who are most impacted.
In case anyone had forgotten the crippling impacts of natural disasters, 2017 served a painful reminder. Hurricanes Irma and Maria left vulnerable people in the Caribbean devastated. Somalia, Ethiopia and Kenya struggled with drought. Floods and landslides wrecked lives and livelihoods in Sri Lanka and Bangladesh. And then there was Hurricane Harvey which, along with the California wildfires, made 2017 the costliest on record in the United States.
Whenever and wherever catastrophe strikes, our thoughts are with those so profoundly affected.
We did not, however, need last summer’s tropical cyclones to understand that something is not working. We did not need Irma and Maria to learn that investments in resilience reduce losses from natural disasters. And we did not need the events of 2017 to know that incentives are too often insufficient to drive action in the most vulnerable regions.
These truths are at heart of the Centre for Global Disaster Protection. Innovation is required to solve such complex humanitarian, political and economic problems. The impacts of recent disasters — and the need to finance reconstruction — have heightened the innovation imperative. They provide an opportunity to deploy financial instruments which catalyze investments in resilience; financial instruments which enable vulnerable communities to recover faster.
RMS too knows that it is possible to stop manufacturing natural disasters. And RMS knows that financial mechanisms could in theory securitize — and therefore incentivize — the potential “resilience dividends” from investments in disaster risk reduction. After all, RMS has been intimately involved in some of the best-known thought-leadership in this space.
Yet equally well understood is the fact that financial structures which incentivize resilience are difficult to implement in practice — in developed and in developing countries. There is no shortage of challenges.
To move from theory to practice; to redirect capital at the required scale, ideas need to be fleshed out, structures need to be robustly designed and cash flows need to be tested. Any new financial mechanisms must pass muster with all stakeholders, lest the intended benefits evaporate.
Since 1988, RMS’ mission has remained constant: to make communities and economies more resilient to shocks through a deeper understanding of catastrophes. Now, with the Centre’s help, experts from the finance, humanitarian and development communities have for the first time come together to refine financial instruments, address practical challenges and provide the interdisciplinary buy-in which mobilizes action.
In this collaborative environment, innovation has happened. The recent launch of a new report on Financial Instruments for Resilient Infrastructure is a product of that innovation.
RMS was commissioned by the U.K. Government’s Department for International Development to run the Centre for Global Disaster Protection’s first “Innovation Lab.” With support from Vivid Economics, re:focus partners and Lloyd’s of London two reports have been published — a 100-page technical report and a 50-page innovation report. Both are freely available here.
The four new financial mechanisms examined in the report can help monetize the resilience dividend, thereby incentivizing both resilient building practices and risk financing. The outcome: less physical damage, fewer lives lost and faster economic recovery whenever nature proves too much.
More is needed, of course. Policymakers and donors have a crucial role to play, not least in sponsoring pilots, funding the quantification of resilience, promoting risk-based pricing, supporting risk finance and advocating duties of care around life, livelihood and shelter.
Thankfully the significant public benefits of resilience justify the investment. And now we have four new financial instruments for donors and the market to pilot in real-world situations.…
Daniel has spent 20 years bringing new ideas to the risk industry. He has responsibility for driving innovative, strategic solutions across RMS’ entire client base. He is also the Global Head of RMS’ Public Sector Group, leading RMS’ relationships at all levels of government.
Daniel has worked closely with public and private entities around the world, advising them on a variety of complex risks, including natural hazards, environmental stresses, malicious attacks and pandemic outbreaks. Deeply committed to education, his work is motivated by a desire to make communities and economies more resilient to acute shocks.
Prior to RMS, Daniel managed the group strategy and development function at an 80,000-employee, £10 billion global healthcare group, serving 30 million customers in over 190 countries. He also has considerable start-up experience, having been a founding team member of an award-winning, SaaS company.
The driving force behind 'Resilience', he received a City of Miami Proclamation recognizing his commitment to delivering urban resilience in the face of sea-level rise and extreme flooding. Daniel has served on the management boards of several charities in areas as varied as education, disability, interfaith social cohesion, grassroots sport and the arts.
Daniel graduated from Oxford, double-first with Honours. He also studied for a Masters at the Humboldt in Berlin and is a graduate of the Center of Creative Leadership.
