UN initiative pushes financial reporting of disaster risk stress-tests

by Artemis on September 25, 2014

The United Nations Climate Summit, held in New York this week, has seen the unveiling of a coalition convened to examine how to embed climate and disaster risk stress testing within banking and securities regulation, investment and accounting practices.

This is the ‘encoding’ of disaster risk and resilience within the financial markets that has been a mantra of insurance and reinsurance broker Willis Group, a key participant in the UN-led initiatives facilitating the development of a post-2015 framework for disaster risk reduction.

The activities which seek to embed disaster risk and resilience within the financial markets of the world, including the disclosure of disaster exposures and accounting for both the negative, caused by exposure to disaster risk, as well as the positive, of response and resilience, are all part of the work which comes under the banner of the Hyogo Framework.

This important work is set to help drive insurance penetration and the need for risk transfer, if initiatives such as the disclosure of disaster risk and the encoding of disaster within the financial system succeed. As a result the insurance, reinsurance and insurance-linked securities (ILS) industries are set to be key participants, particularly when greater levels of risk transfer are required.

Today the United Nations Office for Disaster Risk Reduction (UNISDR) announced the next stage in the evolution of this process, with the convening of public and private sector organisations working together in response to the increasing frequency and severity of extreme weather events.

This initiative is being led by UNISDR, the World Economic Forum and several partners, including Willis Group, PwC, The International Council for Science, Standard & Poor’s Ratings Services, reinsurer Swiss Re, the United Nations Environmental Programme and a number of senior financial regulators.

The core of this initiative is a one-in-100 year solvency “stress test”, similar to that used by the insurance sector to assess its own ability to underwrite risks. The test evaluates the maximum probable annual financial loss that a company, city, or region, could expect once in a hundred years and enables them to manage their risk in a more informed and effective way.

“The aim is to help regulators, companies and investors to evaluate systematically the risk of storms, droughts, floods and other extreme weather events to the financial well-being of public and private sector organisations. A better understanding of climate risk and economic losses from disasters can become a normal feature of investment analysis and financial planning,” commented Mike Wilkins, Managing Director, Standard & Poor’s Rating Services.

“This is a giant step for sustainable development. In the long-term, many lives can be saved and billions of dollars in potential losses from extreme events can be avoided in the future if we succeed in integrating climate and disaster risk into the very heart of our economic decision making,” added Margareta Wahlström, head of UNISDR. “We can avoid investment decisions which create new risks and encourage ones which reduce existing risks. The result will be more resilient economies and safer communities.”

Dominic Casserley, CEO of Willis Group Holdings, who explained the initiative to world leaders at the UN Climate Summit, stated; “Over a quarter of a century, the insurance industry has developed metrics and regulatory frameworks that have transformed our resilience to natural disaster risk, enabling us to meet our commitments to the global economy and society during years of unprecedented natural catastrophe losses. We are sharing the lessons we have learned during this process with the financial sector and the wider economy.”

Willis Group has played a key role in getting to this stage so rapidly, with the firms CEO of its Capital, Science & Policy Practice, Rowan Douglas, leading its work alongside groups such as the UN, UNISDR and the World Bank.

“Applying a one in one hundred year solvency ‘stress test’ to current assets and current climate conditions can help organisations to truly understand their risk and manage it in an economically rational way. Working closely with the UN Secretary General’s Office and regulatory authorities, we aim to apply these tried and tested principles within the global financial system by 2020,” Casserley continued.

Malcolm Preston, Global Leader for Sustainability at PwC also commented; “It is remarkable how quickly and cohesively this is coming together, key professions have now converged and the UN Climate Summit has provided the vehicle. We are simply applying the key principles of accounting to climate-related challenges; material financial risk should be evaluated and communicated to stakeholders.”

The idea of stress testing investors, corporations, supply-chains, banks, cities and other entities which are exposed to climate, disaster and extreme weather risks could herald a new demand for insurance, reinsurance and capital market risk transfer. If disaster risk could be fully embedded into the financial system, meaning that the results of the stress test have to be disclosed, those most at risk will be encouraged to protect themselves, through resilience efforts and financial tools to transfer risk. Those already well-protected will be looked on increasingly favourably by investors and partners, also increasing the value of more robust re/insurance and risk transfer.

The ILS market has a key role to play, in assisting those requiring disaster risk financing to access the capital markets. With many of the entities that are expected to be stress-tested currently outside of the insurance market with no protection at all for much of their disaster risk, structures such as parametric triggers, catastrophe bonds and index-linked covers seem suitable, given the disaster financing required would be a contingent protection.

These initiatives coming out of the UN of late continue to give the impression that what is required for ensuring financial resilience is contingent disaster risk financing. Whether that is traditional insurance or reinsurance, or an ILS structure such as a parametric insurance policy, derivative or catastrophe bond is yet to be defined, but the ILS market will have an opportunity to provide at least come of the much-needed capacity to back these efforts as they move towards becoming reality.

You can access a provisional copy of the UN’s document – Integrating Risks into the Financial System: The 1-in-100 Initiative Action Statement.

Here are some of the other articles covering the announcements, relevant to ILS and reinsurance, from the UN Climate Summit:

UN continues push for “loss & damage” solution. Cat bonds feature.

Climate change catastrophe bonds for Africa to be launched by ARC.

Global reinsurance (and ILS) capital strengthens disaster risk resilience.

Cities around the globe aim to quantify their disaster risks.

Swiss Re pledges $10bn in re/insurance capacity for climate risks.

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