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Insurance Solutions

Formerly Moody’s RMS

Shortly after its landfall, my colleague, Ben Brookes, and I drew attention in the RMS live Harvey updates to the fact that the storm was “not a wind event.” Like Sandy, flood losses, we wrote, would quickly overtake wind losses.

We recalled how Dr. Robert Muir-Wood had insisted back in February 2014 that “water is the new wind.” Those with exposure in harm’s way, he argued, needed to “get to grips with the details of modeling and managing hurricane-driven flood risk.”

It was unsurprising, then, to hear Robert on BBC World News last week describing Hurricane Harvey’s destruction as absolutely avoidable. Yes, Harvey is an extreme event. There were, however, historical precedents for stalling rain storms — and there are clear business cases for investing in resilience before extreme events, rather than just responding after.

Without such an investment, it was clear the bill for Harvey would ultimately find its way to the taxpayer. With most flood risk not insured, much of the costs will be shouldered by homeowners directly, many of whom are simply unaware of both their flood risk and their lack of flood coverage. Even those with insurance are likely covered by the National Flood Insurance Program (NFIP), a program which effectively owes the taxpayer almost US$25 billion already.

Financial Resilience in the Face of Large Flood Events

Members of FEMA’s Urban Search and Rescue Nebraska Task Force One (NE-TF1) go door to door in a neighborhood impacted by flooding from Hurricane Harvey. Source: FEMA

Much has been written in recent days about how Harvey will throw NFIP even further into debt. Under both Trump and Obama administrations, successive FEMA directors have righty pointed out that the program isn’t sustainable in its current form. The premiums homeowners pay simply do not cover the cost of the claims paid out. And with RMS models estimating that NFIP claims from Harvey’s floods could reach the US$10 billion mark, the issue of the “flood protection gap” will doubtless find itself back on top of the political agenda.

By contrast, the mainstream media has written far less about the fact that FEMA transferred a little over US$1 billion of flood risk to the private reinsurance markets earlier this year.

An unprecedented move, this program provides the U.S. taxpayer with US$1.042 billion of financial protection. That protection only kicks in once NFIP has paid US$4 billion in claims. The program then sees FEMA sharing the cost of claims with the private market up until NFIP has paid out US$8 billion. North of US$8 billion, NFIP must lean entirely on the U.S. Treasury again.

NFIP’s “Cornerstone” Already Proving Its Worth

Based on RMS estimates that gross insurance losses accrued in the NFIP will be at least US$7 billion, it seems clear that FEMA will receive a payout from the private reinsurance market. Further, given that RMS estimates a possible loss to NFIP of US$10 billion, not only is it likely that the market will pay FEMA the full US$1.042 billion it assumed when it underwrote NFIP. It is also probable that NFIP will blow through its program.

Capitalized at US$600 billion, the private reinsurance market is well positioned to absorb such a loss. The billion it will likely payout is syndicated across 25 companies. Sure, it will hit their Q3 earnings. It will not, however, make a material dent in their capital, let alone impact their solvency.

That NFIP will likely suffer losses above the cap of its protection will not surprise the actuaries inside FEMA. Indeed, it should not be a surprise to anyone who has been following the NFIP reauthorization closely.

FEMA has been very clear throughout that the US$1 billion reinsurance placement was just the “cornerstone” of a more robust, multiyear risk transfer program it intended to establish. Roy Wright, FEMA’s Deputy Associate Administrator for Insurance and Mitigation, has openly recognized that there is lots of uncovered risk in the NFIP.

A big part of his plan is to strengthen the NFIP’s financial standing by sharing risk with private industry at a price that is fair to the Federal Government. In doing so, FEMA will simultaneously reduce the volatility of NFIP’s annual expenditure and lessen the need to incur additional Treasury debt.

FEMA has doubtless been working hard to develop a preliminary NFIP loss estimate. It wouldn’t surprise me, though, if it chooses to communicate that estimate in the first instance to its panel of reinsurers, rather than to Congress.

The size of the NFIP’s Harvey loss is, however, not the real point. What matters are the steps Congress will permit the NFIP to take in managing the nation’s flood risk going forward.

While of course devastating for the residents of Houston and beyond, the heightened political awareness around NFIP may turn out to be this storm’s silver lining. Hurricane Harvey provides a rare chance for lawmakers to shore up a program whose deficiencies are all too easily ignored without a storm in the headlines.

Indeed, the magnitude of NFIP claims serves to highlight the need for and the value of Wright’s reinsurance program. Premiums of US$150 million were paid in January on the taxpayer’s behalf “for peace of mind, even though FEMA hoped not to experience a loss.” A payout in the region of US$1 billion nine months later looks like a very sound financial investment indeed.

What Good Can Come of an Event That Caused so Much Distress?

Of course, risk transfer is not a panacea. It must ideally be coupled with effective mechanisms to reduce the underlying risk. After all, the first step in closing the “protection gap” ought always to be closing the “prevention gap”. What can be done to reduce the risk that locations outside the 100-year flood zone are flooded in the first place? This must be the first lesson we take from Harvey.

Nonetheless, paraphrasing Dr. Robert Glasser, head of the UN Office for Disaster Risk Reduction: risk transfer is a fundamental arrow in our quiver to reduce disaster risk. It is right, therefore, that Hurricane Harvey amplifies the debate around how the federal government engages with the private markets, both the traditional insurance market and the so-called “alternative” ILS market.

The capital markets in particular have made it clear that they have a strong appetite to assume much more NFIP risk. Their parametric coverage comes with the co-benefits of speed and certainty of payout. It would be shortsighted of Congress not to permit FEMA to explore that appetite further.

Harvey’s political legacy for NFIP ought therefore not to be that it pushes the program over US$25 billion in debt. Rather its legacy must be that it highlighted the importance of a good financial framework at NFIP — and the role of Wright’s reinsurance program therein.

FEMA has a lot to gain from deepening its engagement with industry partners. This would encourage NFIP to both price policies accurately in the first place and incentivize homeowners’ mitigation measures. It will also influence NFIP to better analyze its portfolio risk, leading over time to a more sophisticated program of outwards risk transfer.

Ultimately this deeper engagement will improve FEMA’s ability not only to pay claims when they arise, but also to manage down its debt over the long term.

The desire certainly exists inside FEMA to modernize how rates are set and how risk is transferred. Hopefully it is a desire which Congress shares too. With NFIP up for reauthorization imminently, we have less than a month until we find out.

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March 17, 2019
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A postcard from Manila… Situation: rapid, uncontrolled urbanization and limited enforcement of building codes. Complication: unwieldy administrative procedures, limited funding, a lack of technical expertise and #NIMTOO. Result: an alarming rise of building vulnerability in hazard-prone communities putting millions of low-income people at extreme risk. While many local government officials recognize this problem, progress is painfully slow. Housing vulnerability continues to rise. What to do?   The Issue of Our Age? According to my favorite bricklayer, Dr. Elizabeth Hausler, housing vulnerability is the defining issue of our age. By 2030, three billion people will live in substandard homes. That’s one third of the world’s population. Just ask Santiago Uribe Rocha, the first Chief Resilience Officer employed in a non-OECD country. In Colombia over the past 20 years, more than ten million people have moved to major cities like his, Medellín. The lack of affordable housing has led many of these low-income families to settle on the outskirts, often building haphazardly with poor quality material. According to CENAC (Centro de Estudios de la Construcción y el Desarrollo Urbano y Regional), three out of every five new homes built in Colombia today are of “informal origin”. In other words, 60 percent live in homes that are built without any legal procedures or formal design process. Despite acknowledging the issue, city governments often lack the means to effectively deal with increasingly vulnerable housing stock. Cumbersome bureaucracies complicate matters. In some neighborhoods, city officials require over six months to approve the retrofit of a single home. The result: hundreds of thousands of low-income families remain significantly at risk of death, injury and destitution in an earthquake. Change Is Building RMS has been working closely with Build Change since 2013. By sharing research, expertise and resources, we’ve been supporting the non-profit’s preventive programs in Latin America, the Caribbean, Nepal and, most recently, Southeast Asia. The partnership, focused on promoting the benefits of retrofitting homes for low-income families living in informal neighborhoods, is closely aligned with RMS’ overarching, societal purpose. After all, for the last 30 years, RMS’ mission has remained the same: to make communities more resilient through a deeper understanding of the impacts of extremes. With RMS’ support, Build Change has been able to develop the basis for successful retrofit projects. Shared value abounds… The local governments have been convinced to effect and enforce changes to urban planning and building ordinances. The local construction industry has been upskilled and employed. The local insurers are finding new opportunities to offer affordable policies. The local residents now have disaster-resilient homes and insurance coverage. Quantifying Resilience; Increasing Institutional Urgency Catastrophe risk models have been vital to this process. By combining science, technology, engineering and data to simulate the potential impacts of future disasters, RMS modeling puts a number on the potential impacts of “informal” housing. Moreover, the models can be used to evaluate how risk might reduce if mitigating measures are put in place. A virtuous circle often results: quantifying the value of building practices drives funding; funding helps protect more communities; more communities protected demonstrates the value of resilient building practices; more funding follows. For example, in 2016 RMS quantified the cost-effectiveness of a proposal for a scaled retrofit program in Bogotá, Colombia. Preliminary analysis showed that over 120,000 deaths and US$2.8 billion could be avoided in a 1-in-200-year event by retrofitting homes in the five neighborhoods studied. RMS and Build Change also demonstrated that the project would deliver an attractive return on investment. Analysis showed that the retrofits could be completed using existing local skills, with minimal training, and for less than half the price of demolishing to rebuild. In this case, the modeled output did not just increase the institutional urgency to deal with the problem of vulnerable housing. The analytics also contributed to the wider acceptance in Colombia of retrofitting as a viable solution. Now What? In approximately five years of formal partnership, RMS and Build Change have collaborated to greatly improve the safety of seismically-vulnerable communities. By combining our risk modeling expertise and institutional support with Build Change’s technical knowledge and grass roots approach, we’ve not only demonstrated that retrofitting in vulnerable neighborhoods is possible. We’ve also shown it’s a cost-effective way to save lives and livelihoods. As a result, the Government of Colombia recently made the retrofitting of 600,000 homes an urgent, national priority. Of course, our work in Latin America is by no means done. And collaborations with Build Change continue in Haiti and Nepal as well. Immediate attention, however, has shifted to the Philippines. It’s too early to judge the outcomes. But with 69 million low-income people living in 15.6 million vulnerable homes today, the potential to make a difference is huge. By quantifying that potential, we hope to develop a compelling business case to address what is arguably the issue of our age. By putting a number on the resilience dividend, we hope to attract the #ResilienceFinance needed to make some of the world’s most densely populate cities significantly safer.…

November 13, 2018
Financing Resilience

Almost one and a half million people have died in natural disasters over the past 20 years. This is a waste of life; a waste of potential. Natural disasters also have a massive economic impact. Our models suggest natural catastrophes cost the world’s poorest countries almost US$30 billion a year on average. Hard-won development gains are regularly wiped out — and it is the poor and the vulnerable who are most impacted. In case anyone had forgotten the crippling impacts of natural disasters, 2017 served a painful reminder. Hurricanes Irma and Maria left vulnerable people in the Caribbean devastated. Somalia, Ethiopia and Kenya struggled with drought. Floods and landslides wrecked lives and livelihoods in Sri Lanka and Bangladesh. And then there was Hurricane Harvey which, along with the California wildfires, made 2017 the costliest on record in the United States. Whenever and wherever catastrophe strikes, our thoughts are with those so profoundly affected. We did not, however, need last summer’s tropical cyclones to understand that something is not working. We did not need Irma and Maria to learn that investments in resilience reduce losses from natural disasters. And we did not need the events of 2017 to know that incentives are too often insufficient to drive action in the most vulnerable regions. These truths are at heart of the Centre for Global Disaster Protection. Innovation is required to solve such complex humanitarian, political and economic problems. The impacts of recent disasters — and the need to finance reconstruction — have heightened the innovation imperative. They provide an opportunity to deploy financial instruments which catalyze investments in resilience; financial instruments which enable vulnerable communities to recover faster. RMS too knows that it is possible to stop manufacturing natural disasters. And RMS knows that financial mechanisms could in theory securitize — and therefore incentivize — the potential “resilience dividends” from investments in disaster risk reduction. After all, RMS has been intimately involved in some of the best-known thought-leadership in this space. Yet equally well understood is the fact that financial structures which incentivize resilience are difficult to implement in practice — in developed and in developing countries. There is no shortage of challenges. To move from theory to practice; to redirect capital at the required scale, ideas need to be fleshed out, structures need to be robustly designed and cash flows need to be tested. Any new financial mechanisms must pass muster with all stakeholders, lest the intended benefits evaporate. Since 1988, RMS’ mission has remained constant: to make communities and economies more resilient to shocks through a deeper understanding of catastrophes. Now, with the Centre’s help, experts from the finance, humanitarian and development communities have for the first time come together to refine financial instruments, address practical challenges and provide the interdisciplinary buy-in which mobilizes action. In this collaborative environment, innovation has happened. The recent launch of a new report on Financial Instruments for Resilient Infrastructure is a product of that innovation. RMS was commissioned by the U.K. Government’s Department for International Development to run the Centre for Global Disaster Protection’s first “Innovation Lab.” With support from Vivid Economics, re:focus partners and Lloyd’s of London two reports have been published — a 100-page technical report and a 50-page innovation report. Both are freely available here. The four new financial mechanisms examined in the report can help monetize the resilience dividend, thereby incentivizing both resilient building practices and risk financing. The outcome: less physical damage, fewer lives lost and faster economic recovery whenever nature proves too much. More is needed, of course. Policymakers and donors have a crucial role to play, not least in sponsoring pilots, funding the quantification of resilience, promoting risk-based pricing, supporting risk finance and advocating duties of care around life, livelihood and shelter. Thankfully the significant public benefits of resilience justify the investment. And now we have four new financial instruments for donors and the market to pilot in real-world situations.…

Daniel Stander
Daniel Stander
Global Managing Director, RMS

Daniel has spent 20 years bringing new ideas to the risk industry. He has responsibility for driving innovative, strategic solutions across RMS’ entire client base. He is also the Global Head of RMS’ Public Sector Group, leading RMS’ relationships at all levels of government.

Daniel has worked closely with public and private entities around the world, advising them on a variety of complex risks, including natural hazards, environmental stresses, malicious attacks and pandemic outbreaks. Deeply committed to education, his work is motivated by a desire to make communities and economies more resilient to acute shocks.

Prior to RMS, Daniel managed the group strategy and development function at an 80,000-employee, £10 billion global healthcare group, serving 30 million customers in over 190 countries. He also has considerable start-up experience, having been a founding team member of an award-winning, SaaS company.

The driving force behind 'Resilience', he received a City of Miami Proclamation recognizing his commitment to delivering urban resilience in the face of sea-level rise and extreme flooding. Daniel has served on the management boards of several charities in areas as varied as education, disability, interfaith social cohesion, grassroots sport and the arts.

Daniel graduated from Oxford, double-first with Honours. He also studied for a Masters at the Humboldt in Berlin and is a graduate of the Center of Creative Leadership.

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