Why Companies Should Disclose Disaster Risk

It’s time for us to take our knowledge and share it with the business community—and to be far more candid about disclosing disaster risks.

Driven by demographics, economic development and climate change, disaster is playing a greater part in life in the West than ever before. In 2013, the total insured loss from 308 natural and man-made disasters was $45 billion; natural catastrophes were responsible for $37 billion of that. Almost 26,000 people lost their lives or went missing, while Swiss Re has pegged the total economic losses  at around $140 billion. Increasingly violent and frequent weather events are affecting communities and businesses, particularly in urban areas with dense populations and more assets at risk.

Against this backdrop, leading figures from governments and intergovernmental institutions, including the World Bank, the OECD, the International Insurance Society and key players in global financial markets, gathered in London recently to discuss the need for greater disaster resilience across the globe. The meeting, under the auspices of the United Nations, focussed on the UN’s Hyogo Framework, a global action plan to reduce disaster losses. But too few people in business are aware of this framework, up for renewal next year, and its role in reducing risk.

Read: Business Leaders Call for Disaster Risk Disclosure 

Simply reacting is no longer enough. The global business community has a fundamental role to play in reduction—by more fully reporting disaster exposure in describing a company’s performance and health. Companies should report publicly on their resilience against natural disasters.

Doing this would advance several goals. Companies would have incentives to build resilience, making themselves stronger and better positioned to grow. When businesses feel they are protected from major problems, they have the confidence to invest and create jobs. Beyond being an end unto itself, resilience actually leads to growth and prosperity. A healthier private sector would also drive more economic activity. Business is responsible for around 80 percent of all investment worldwide; this proposal would promote and protect that critical activity.

Finally, we could expect stronger companies to translate into stronger communities, building new resilience for society against an increasingly risky world.

We have the power—particularly in the insurance industry—to respond to these greater threats. The first step in managing risk is to identify it.

We need to make this change because disaster is playing a greater part in human life than ever before. Of the 25 most costly insured catastrophes in the last 40 years, two-thirds have happened since 2001, and the last three years have seen the greatest amount of earthquake damage in countries with high Human Development Index scores. The UN’s global assessment of risk from disasters showed direct losses of $2.5 trillion so far this century. An intelligent guess would be that we could see annual losses average $200 billion from now on—10 times the level 30 years ago.

There are two main drivers for this sobering reality.

First, demographics and economic development. Humanity is more numerous and richer than ever before. In the 1960s, there were three billion people in the world, and just one-third of us lived in cities. Today, we’re at over seven billion, and more than half of us are urban dwellers. By 2050, many forecast we will be close to 10 billion and that two-thirds of that population will be in cities. We will have gone from one billion citizens to over six billion urbanites, with all the concentration risk that implies. We love to build near the water, so cities are especially prone to disaster risk on the coast.

Read: Companies Forced to Improve Risk Management Disclosures: Guy Carpenter

The Intergovernmental Panel on Climate Change has found that economic losses from natural disasters are higher in developed countries. But predictably, losses as a proportion of GDP and fatality rates are higher in developing countries.

The second factor is climate change. The evidence is compelling—anthropogenic climate change is real—but we still have to improve our understanding of the specific impacts. And we must prepare for more violent, more extreme weather.

When you put these two factors together, you get the most challenging outcomes. The combination of economic and demographic development with climate change means, as UN Secretary-General Ban Ki-moon put it, “economic losses are out of control.” In the private sector, the risks are material for many companies, so they have more concerns about the future, and are less confident about investing and creating jobs.

We have the power—particularly in the insurance industry—to respond to these greater threats. The first step in managing risk is to identify it.

We have the experience to help the financial sector and the business community better evaluate the risks we all face. We learned the hard way in our own industry with our existential crisis in the 1980s, culminating in the losses from Hurricane Andrew that put several insurers out of business and led to wholesale reform.

After that episode, we got smarter about understanding and pricing risk. We also got smarter about sharing it, not least between the public and private sectors. We should now share that experience and learning beyond our sector. And from our perspective, there is one initiative that would trigger a major behavioural change in the way the private sector views risk: having companies report natural disaster risk and resilience.

Read: Could a Natural Disaster Lead to Insurer Insolvency?

The global financial crisis underlined that financial reporting—confined within a narrow set of accounting conventions—is insufficient to understand the full range of business risks.

But still, some of the most important risks are completely absent from investors’ minds. Investors need access to meaningful information that allows them to make informed judgements about the potential of a business, its opportunities and, crucially, its risks.

The techniques that our industry has developed over the last 20 years mean that we can create a one in 100 and a one in 20 natural hazard risk measure as good proxies for solvency and profit risk, and use the annual average loss estimate as a simple comparator tool. It’s all part of what the organization Accounting for Sustainability describes as a move towards “a fundamental shift in decision-making that results in sustainable business models.”

Better disclosure will lead to improved valuations and pricing for capital, with the better returns that implies. Today, investors have an uncertain, unquantified view of the risks companies face. If all companies articulated and disseminated the risks they face, it can only lead to better allocation of capital to those businesses that act on this information.

This is not an idea on the fringes: two key leaders in the financial markets, Michael Bloomberg and Mary Schapiro, have both argued that investors should have access to standardized data on corporate resilience and sustainability.

The financial reporting of natural disaster risk and resilience would create even greater incentives for companies to understand risk and protect themselves against a riskier world, to put in place the resilience that will give them the confidence to invest for the future.

It might also open up access to insurance for those who are less protected. Fewer than 10 percent of earthquake losses are currently insured, emerging market insurance penetration is often low, and small businesses are less likely to be insured against natural disasters than larger ones.

In addition to the financial reporting process, there is a need for a better understanding of the science of disasters and how we model them. The insurance industry has long partnered with the scientific community; that partnership will continue to be critical. At Willis, we employ hundreds of scientists and analysts—not just as specialists, but also in our business—in addition to investing tens of millions of dollars in platforms, models, data and the fifty universities and institutions we partner with through the Willis Research Network. All of that is to understand risk better.

We are witnessing a revolution in analytics and modelling, creating a platform for the integration of data, algorithms, mapping and analysis that can support greater disclosure of resilience. But business also needs to play its role in tackling this issue. Embedding measured disaster risk into how businesses describe themselves would represent a significant advance, producing a better, more sustainable and more resilient global economy.

Working together, civil society, the financial sector and business can reduce very significantly the impact of natural disasters—in both human and financial terms.

Dominic Casserley has been CEO of Willis Group since January 2013.

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Copyright 2014 Rogers Publishing Ltd. This article first appeared in the August 2014 edition of Canadian Insurance Top Broker magazine

This story was originally published by Canadian Insurance Top Broker.