July 14, 2011
A bridge between 2 worlds: Desire or need?
Can we survive working apart?
Basel accords, Quantitative easing, Financial overhauling, Counterparty risks, Earthquakes, Droughts, Floods, Currencies war, Volcano eruptions, Global warming, US credit rating on watch!…
you name it!
Risks are all around us. They grow up and hit fast from every angle, and the potential financial losses are so high that could sink many unprepared businesses… and countries?
What if an unforeseen concurrence of catastrophes took place in a given period of time, in critical locations? Is it a fictional scenario? What would be the impact?
These questions may be answered if we ask ourselves how many times we have seen governments join forces with academics and private concerns to assess, quantify and proactively manage catastrophes. With very few exceptions focused on visibly catastrophic risks such as floods, earthquakes and hurricanes, it is more common to see such joint efforts of multidisciplinary teams when the catastrophe is around the corner.
Systems to prevent, mitigate and develop pre-loss financial structures for eventual catastrophes are also “black swans”, so rare...
As of today, the most visible bridges linking public and private players in the catastrophic risk arena are the Insurance Linked Securities (ILS): financial instruments set up based on statistical information that may be as good in quality as the statistical information that drove the world into the current financial turmoil due to the systemic exposures to Real-Estate Backed Securities and their derivatives.
Reading year 2010 and 2011 articles about epidemics in the Caribbean, earthquakes and floods in Asia, droughts in Russia, floods in South America and hurricanes threatening once again to strike the Gulf of Mexico in their annual drive, I struggled to find articles about structures being set up to proactively manage these risks. In the internet, wherever I “googled” for the phrase “manage risks”, I found myself reading an article about Basel III, Solvency II, Operational risks - in financial and non-financial institutions - and a myriad of products, services and training focused on enterprise related risk exposures.
Is it that catastrophic exposures don’t impact corporations, and the private or public finances? Is it that the economic loss expected after a catastrophe is negligible when compared to losses due to anthropogenic flaws in the financial systems?
In my previous article I asked: “Is it possible to build bridges between the 2 ERM worlds, the world of financial institutions and the world of NON-financial institutions?”
Now I move a step further with a question that has been agitating me for many nights: A bridge: is it a desire or critical for our survival?
I am convinced that earthlings (not different beings), in financial and non-financial institutions, are striving every day for a similar outcome: Improve the human ability to predict the consequences, timing and probabilities of uncertain events, to procure the best possible quality of life for individuals, families, societies and countries as a whole.
But I also have the feeling that we, risk practitioners, are exchanging knowledge and resources through professional groups and academic institutions in a way that is too focused on the day to day risk exposures that can be measured in the short term and for which the impact can be “seen” within the financial boundaries of our organizations and compensation systems, in public and private concerns alike.
I don’t mean to say that such activities are irrelevant. They are relevant and historically proved to be effective in turbulent times such as the moment we are currently living. What I mean to say, is that we, risk practitioners, MUST also have the initiative to allocate time and resources to work fast and effectively in structuring solutions for the huge implications of the potential concurrence of catastrophes taking place in a given moment, in critical geographical locations.
A report about catastrophes around the world during year 2010 issued by “sigma”, a publication of Swiss Re, one of the world’s biggest insurers, details that 260.000 people died due to catastrophic events in year 2010 alone: the highest number of deceased since 1976. Over 222.000 in Haiti’s earthquake… They further explain that financial losses covered by insurance were estimated in merely 16% of the total: USD 36 billion in insured losses for losses totaling USD 222 billion.
A recent report from Munich Re, the world’s biggest re/insurance corporation, underlines that year 2011 is already the most expensive year in catastrophic losses in human history. USD 265 billion (Euro 190 billion) have been lost since January until June 2011. Before year 2011, the most expensive year had been 2005 with losses totaling USD 220 billion. The main catastrophe accounting for 2011 losses is the earthquake and tsunami that devastated Japan in March, with losses reaching USD 210 billion, placing it as the single worst natural catastrophe in human history. Before Japan, the single worst natural catastrophe was hurricane "Katrina" which in 2005 unloaded USD 125 billion worth in damages. Another interesting fact from Munich Re: insured losses in the Japan catastrophe amount to about USD 30 billion (USD 60 billion for Katrina), mainly because damages to the nuclear reactor Fukushima are not insured. Earthquakes and floods in Australia and Nueva Zealand, as well as tornadoes in USA, make the rest of the losses during 2011... and +5 months and the Atlantic hurricane season remaining…
Imagine a magnitude 8 earthquake in San Francisco, a flood in the Chinese “Pearl River” delta, or both, concurring with a terrorist attack impacting the critical IT infrastructure in India.
Can you imagine the impact on the world economy of such levels of disruptions in the US, India and China?
Add an eventual downgrade of the US credit rating… Can you value the impact? I can only imagine.
Such events only need to concur in a period of time short enough - within months or maybe a couple of years – to produce damages in values never seen before.
Insurance is the most visible financing tool available, but it is far from being able to provide financial stability in a global worst case scenario. New financial tools must be designed and deployed without delay.
Are such scenarios realistic? In my humble opinion we haven’t developed the systems that provide consistent and reliable data to assess, quantify and proactively manage potential catastrophes and their financial consequences in a given country, less in the globalized interdependent world where we live today. In short, I believe there is no reliable answer to that question.
The design of an information system may be an interesting way to start building bridges linking governments, academics and private concerns, based on the experience and systems built by ERM practitioners in Financial Institutions and non-financial Institutions.
“Maybe I am just a dreamer…” as John Lennon would sing, but I certainly hope that my nightmares and those sleepless nights thinking about concurrent catastrophes never realize, anywhere, ever… Am I dreaming again?
In the meantime I pray every day:
“Please, God, have mercy with us and our future generations”
Posted by Gustavo at 10:14 PM
| Comments (0)
