Prepare now for the next catastrophe

March 2021  |  SPECIAL REPORT: MANAGING RISK

Financier Worldwide Magazine

March 2021 Issue

We do not know what the next global threat will be, but we must prepare for it. Our aim must be to create both organisational and financial resilience.

The pandemic has painfully demonstrated that many risks have become systemic, linked through technological revolutions, interconnected systems and economic globalisation.

Our ‘2020 Risk Manager Survey’ gives a pre-coronavirus (COVID-19) picture of the most threatening risks to business in the short (12 months), medium (three years) and long  (10 years) term.

Digital risks, including cyber and data fraud and theft, are in the top three threats across all time horizons. Economic uncertainty appears in the short and medium term. Over the long term, the implications of climate change, environmental damage and natural catastrophes are paramount, along with changing customer behaviour.

When we conduct our next Risk Manager Survey in 2022, global health catastrophes and geopolitical risks may have joined these threats at the top of the list. Yet, there are others on the horizon whose potential severity we do not realise, or there may be something truly unexpected.

This is why a risk-based approach is an essential management tool to create resilience. We must anticipate the risks we can envisage, like those identified in our 2020 survey and the World Economic Forum ‘Global Risks Report’ published in January 2021.

At the same time, risk and business continuity management must be designed to respond to any crisis. If the approach is too specifically targeted, say to cyber risks, we may lack the flexibility to recover if the initiating event turns out to be an extreme geomagnetic storm that knocks out electrical grids.

Building resilience

The pandemic has shown us that there are two aspects to creating resilience to major catastrophic and systemic risks in the future: (i) sound risk and business continuity management; and (ii) financial support for costs related to the event, including government control measures, that cannot be insured.

In terms of preparation, horizon scanning, scenario exercises for low frequency-high severity events and understanding of dependencies, especially in supply chains, all need to be part of disaster planning and business continuity management. This work should allow businesses to reduce their vulnerabilities and create alternative methods of working. They will still look for ways to reduce the financial impact of their remaining exposures.

During the pandemic, many businesses are suffering financial stress and sharp falls in cash flow, often as a result of measures to control the spread of the pandemic, such as lockdowns and travel bans. Insurance, long a source of financial resilience for businesses, has been of limited value. While businesses have not suffered any damage to property, most policies require physical damage as a trigger for business interruption cover to kick in.

Today, there is little if any capacity available for non-damage business interruption (NDBI) risks. At the same time, the pandemic has shone a harsh light on the costs that many organisations could face from a systemic risk and subsequent government control measures. These losses are well beyond the capacity of the private insurance market.

We argue that a public-private partnership (PPP) is essential to responding to the business consequences of future systemic risks or extreme catastrophic events. We have proposed a European Resilience Framework for Catastrophe Risks that would create capacity for NDBI insurance.

This framework would have sound corporate risk management and an insurance mechanism with support from the reinsurance industry at its foundation, but with the potential for participation from other financial institutions, such as capital markets. For such a scheme to work, the European Union (EU) must be involved; systemic risks do not respect national borders. The EU could provide help in creating the scheme, for example by establishing an expert group for data sharing and risk modelling. Ultimately, a European financial backstop is likely to be necessary.

There are already a number of national PPPs for risks like terrorism, floods and earthquakes among European member states, but they do not necessarily meet the needs of international businesses that are operating across many borders.

We are already working with the European Insurance and Pensions Regulatory Agency (EIOPA) to provide a view from corporate risk and insurance managers for the European Commission (EC) in its consideration of the pandemic protection gap and the case for EU intervention. EIOPA’s Paper on Shared Resilience Solutions for Pandemics for the EC is based on the views of representatives of commercial insurance buyers, insurers, reinsurers and brokers at European level. It proposes options for PPPs to create protection against future pandemics to be explored at national and European level.

At the same time, we have urged the EC to promote risk management at enterprise and national level. Only by doing this will we strengthen our resilience to catastrophic risks.

Other risk financing

Overall, in the insurance market, the coverage on offer has shrunk and the prices are higher. This process was already underway before COVID-19 emerged and it has continued. It is difficult for a risk and insurance manager to argue the value of insurance which costs more and provides less to a chief financial officer (CFO) in the current circumstances. This means companies are examining other methods of creating financial resilience. One approach is the use of self-insurance mechanisms, such as captive insurance companies.

Our survey revealed that even pre-COVID-19, many risk managers were looking at putting more risk into the company captives. This is a trend we believe has continued and possibly accelerated as a result of the market conditions. The formation of new captives is a slower process because of the necessary corporate decisions, capitalisation and regulatory permission. However, by 2022-23, we may see that there has been a real rise in the number of captives.

Alternative risk transfer mechanisms, such as catastrophe bonds, can also provide capacity that is not available in the commercial market or is considered too expensive. Such financial instruments have typically been used by reinsurers, but there are signs of growing corporate interest. Brokers and insurers are also looking at innovations that will respond to customers’ need for cash flow in the event of a catastrophe, which the pandemic has highlighted. Using parametric measures, such as rainfall or windspeed in storm conditions, can trigger a rapid claims payment and allow the insurer more confidence in loss estimation.

Looking beyond the pandemic

Good risk management will create resilience for companies to a broad range of catastrophe and systemic risks. Analysing operations, identifying vulnerabilities especially through interdependencies, scenario modelling and the creation and regular testing of business continuity and recovery plans, are essential to the process.

Combining such enterprise-wide risk management with new PPPs that strengthen information sharing, analysis and financial support provides a unique opportunity to strengthen our resilience as organisations and as societies.

 

Dirk Wegener is the president of the Federation of European Risk Management Associations (FERMA). He can be contacted on +32 (2) 761 9432 or by email: enquiries@ferma.eu.

© Financier Worldwide

BY

Dirk Wegener

European Risk Management Associations (FERMA)

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