Let’s start by celebrating goal achievement. Last week, Jeff Bezos’ Blue Origin took off — and then returned back to Earth. Mission accomplished. But, from 100 kilometers above the Earth’s surface, looking back at our planet, what’s the state of our global goal achievement? Do we even have goals?
I ask this as over 50,000 delegates descend on Paris this week for the 21st Conference of the Parties to the United Nations Framework Convention on Climate Change. Or more simply, COP21.
COP21 offers the unique prospect of 196 countries achieving a (sort of) legally binding agreement on climate change: to keep global warming below 2°C by reducing greenhouse gases. But what would a “good goal” for COP21 look like and would it ever be achieved?
Set your goal. Measure it. Achieve it.
It’s easy to get cynical about achieving BHAGs (Big Hairy Audacious Goals), but maybe a template for success has emerged. In 2000, the United Nations agreed to eight BHAGs through its global Millennium Development Goals. Goal number four was to reduce child mortality by two-thirds within 15 years across 138 developing countries.
A 50% reduction in child mortality in 15 years
In 2010, Hans Rosling’s celebrated TED talk outlined a two million annual reduction in child deaths under the age of five within a decade, down to 8.1 million per year. By the end of 2015, we will be below six million deaths per year, almost halving in 15 years. That’s still too high, and many countries will miss the two-thirds reduction target, but nonetheless it is a huge improvement.
As Rosling points out, the Millennium Goals were strong due to measurable targets. Clear targets, at individual country level, have driven the ability to lobby for increases in financial resources for clean water, immunization and antibiotics, motivated by strong partnerships and innovations in service delivery.
A goal for climate change
Rio in 1992 is remembered for establishing climate change as being caused by humans, and more specifically, primarily the responsibility of the industrialized countries.
France, as host, wants to build on the momentum of Rio, but also learn lessons from past summit failures. So, much of the COP21 framework has been defined and negotiated in advance. Francois Hollande has already agreed with top-polluter China on a mechanism to monitor cuts every five years.
The squabbling that characterized Copenhagen in 1999 will be minimized, and high expectations set for those attending, such as encouraging heads of state to arrive at the start, rather than jetting in at the end.
Frequent communication with every country participating has been critical. As conference chair, Laurent Fabius, French Foreign Minister told the FT last week “Negotiators sometimes hold firm positions that only ministers can unlock, I know their bosses – I see them all the time. We talk often, it helps”.
Paris will pull out all the stops to get an agreement, but will we be willing to accept the short-term costs and constraints to slow down climate change? The answer is probably yes.
So what are the lessons for COP21?
As Jeff Bezos’ Blue Origin extreme rocket recycling shows, individual changes in our daily behavior such as recycling and energy conservation can affect climate change, but ultimately, changes need to be government led, especially around energy generation and emission control. Whether world leaders are ready to be held legally accountable for missing their climate goals is an ongoing issue.
Nonetheless, as the Millennium Goals show, clear and well-defined targets, annually measured (“are we there yet?”) create momentum to drive change forward. The success of COP21 will be defined by whether emerging sub-goals are specific, measurable, achievable, realistic, and time bounded. Now that would be smart.
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August 03, 2015
What Can the Insurance Market Teach Banks About Stress Tests?
In the last eight years the national banks of Iceland, Ireland, and Cyprus have failed. Without government bailouts, the banking crisis of 2008 would also have destroyed major banks in the United Kingdom and United States.
Yet in more than 20 years, despite many significant events, every insurance company has been able to pay its claims following a catastrophe.
The stress tests used by banks since 1996 to manage their financial stability were clearly ineffective at helping them withstand the 2008 crisis. And many consider the new tests introduced each year in an attempt to prevent future financial crises to be inadequate.
In contrast, the insurance industry has been quietly using stress tests with effect since 1992.
Why Has the Insurance Industry Succeeded While Banks Continue to Fail?
For more than 400 years the insurance industry was effective at absorbing losses from catastrophes.
In 1988 everything changed.
The Piper Alpha oil platform exploded and Lloyd’s took most of the $1.9 billion loss. The following year Lloyd’s suffered again from Hurricane Hugo, the Loma Prieta earthquake, the Exxon Valdez oil spill, and decades of asbestos claims. Many syndicates collapsed and Lloyd’s itself almost ceased to exist. Three years later, in 1992, Hurricane Andrew slammed into southern Florida causing a record insurance loss of $16 billion. Eleven Florida insurers went under.
Since 1992, insurers have continued to endure record insured losses from catastrophic events, including the September 11, 2001 terrorist attacks on the World Trade Center ($40 billion), 2005 Hurricane Katrina ($60 billion—the largest insured loss to date), the 2011 Tohoku earthquake and tsunami ($40 billion), and 2012 Superstorm Sandy ($35 billion).
Despite the overall increase in the size of losses, insurers have still been able to pay claims, without a disastrous impact to their business.
So what changed after 1992?
Following Hurricane Andrew, A.M. Best required all U.S. insurance companies to report their modeled losses. In 1995, Lloyd’s introduced the Realistic Disaster Scenarios (RDS), a series of stress tests that today contains more than 20 different scenarios. The ten-page A.M. Best Supplemental Rating Questionnaire provides detailed requirements for reporting on all major types of loss potential, including cyber risk.
These requirements might appear to be a major imposition to insurance companies, restricting their ability to trade efficiently and creating additional costs. But this is not the case.
Why Are Stress Tests Working For Insurance Companies?
Unlike the banks, stress tests are at the core of how insurance companies operate. Insurers, regulators, and modeling firms collaborate to decide on suitable stress tests. The tests are based on the same risk models that are used by insurers to select and price insurance risks.
And above all, the risk models provide a common currency for trading and for regulation.
How Does This Compare With the Banking Industry?
In 1996, the Basel Capital Accord allowed banks to run their own stress tests. But the 2008 financial crises proved that self-regulation would not work. So, in 2010, the Frank-Dodd Act was introduced in the U.S., followed by Basel II in Europe in 2012, passing authority to regulators to perform the stress tests on banks.
Each year, the regulators introduce new stress tests in an attempt to prevent future crises. These include scenarios such as a 25% decline in house prices, 60% drop in the stock market, and increases in unemployment.
Yet, these remain externally mandated requirements, detached from the day-to-day trading in the banks. Some industry participants criticize the tests for being too rigorous, others for not providing a broad enough measure of risk exposure.
What Lessons Can the Banking Industry Learn From Insurers?
The Bank of England is only a five-minute walk from Lloyd’s but the banking world seems to have a long journey ahead before managing risk is seen as a competitive advantage rather than an unwelcome overhead.
The banking industry needs to embrace stress tests as a valuable part of daily commercial decision-making. Externally imposed stress tests cannot continue to be treated as an unwelcome interference in the success of the business.
And ultimately, as the insurance industry has shown, collaboration between regulators and practitioners is the key to preventing financial failure.…
Matthew leads the company’s core business, which provides the industry’s leading catastrophe models and data products. He is also responsible for the RMS capital markets and emerging risks business, and corporate marketing function. Previously, Matthew was Group Executive for Global Client Development. Since 1992, Matthew has been a leading advocate for catastrophe modeling and risk assessment in the insurance and reinsurance industries. He joined RMS in 1996, establishing the company’s European operations in the same year. Prior to joining RMS, Matthew managed risk assessment and emergency planning for nuclear, chemical, and offshore industries. He holds a bachelor’s degree in mechanical engineering from University of Aberdeen.