Rowan Douglas, CEO, and Sophie Abraham, Policy Analyst, of Willis Group propose options for the new international disasters framework to ensure that the financial and private sectors account for disaster risk.

This blog is part of CDKN’s blog series: ‘Rethinking a new global agreement for disaster risk reduction’   which invites contributors to outline their innovative and concrete ideas for the post-2015 disaster risk management agreement. If you would like to contribute, please contact Amy Kirbyshire.

Over the last decade, the Hyogo Framework for Action (HFA) has remained largely unrecognised across the financial and private sectors with the exception of a relatively small (albeit growing) community. As we begin gearing towards, and preparing for, the 3rd World Conference on Disaster Risk Reduction in March 2015, there is a significant opportunity at hand to incorporate the financial and private sectors as key champions in the successor to the HFA.

How can we include financial and private sectors as champions for disaster risk management in the HFA2?

The global re/insurance sector suffered a crisis in the late 1980s and early 1990s, largely driven by natural disasters, and subsequently experienced a long journey of development resulting in enhanced structural resilience to natural disaster risk. This phenomenon provides a number of invaluable lessons which can, and should, be applied to achieve similar trends towards resilience within the wider global financial system.

Indeed, the global re/insurance market almost collapsed as a result of unprecedented losses from a number of natural catastrophes during that period, and it soon became clear that the sector’s modus operandi of the last 300 years was no longer sustainable in managing such levels of risk. In short, during the decade from 1993 to 2003, the entire sector underwent a transformation which assumed a deeper understanding of the roles of, and fluid relationship between, capital (how underwriters evaluate and price natural disaster risk), science (the rise of sophisticated natural catastrophe modelling and analytics), and public policy (the regulation of insurance contracts to deliver a 1:200 year level of tolerance), in managing natural disaster risk. The year 2011 witnessed record global catastrophe losses with over $120bn in claims across both developed and emerging economies. Yet, the re/insurance sector managed well within normal market operations, a trend that continued with super storm Sandy in 2012.

Though the re/insurance sector has a long way to go, and represents only one of many actors in the global financial system, a similar transformation that paves the way for the encoding of disaster risk and resilience into financial regulation, accounting, and other forms of capital, is crucial in the face of growing levels of risk due to the increasing frequency and intensity of natural catastrophes.

Is such a transformation realistic?

Currently, a company’s resilience to disaster risk is not reported or evaluated, and is largely ignored by markets, analysts and investors. As such, there is no incentive for companies to reduce risk and build resilience. If disaster resilience evaluation was institutionalised, however, companies that exhibit well managed vulnerability to natural hazards would see their valuation improved in relation to their more exposed competitors, and would become more desirable stocks due to the improved quality of their earnings. Disaster resilience evaluation could also be applied to the valuation of other transactions and financial instruments, from the interest charged on sovereign, corporate or personal bank loans, to bond prices and, in appropriate instances, credit ratings.

The outcome would be that natural disaster resilience is valued: increased disaster risk exposure would discount valuation and attraction of assets, while lower risk and reduced vulnerability would be positively valued. Capital owners would become incentivised to achieve adequate resilience from current and future levels of disaster risk to avoid impairment of their valuations or liquidity of assets.

The successor to the HFA can provide the global agreement to undertake the preparations necessary to adopt these reforms. In our opinion, the new framework would ideally include the following components.

Strategic Goals: A fourth strategic goal should be added to mainstream the embedding of disaster risk and resilience within the financial system. For instance, “The incorporation of disaster risk and resilience into public, private and mutual accounts, financial regulation, investment processes and transactions.”

Priorities for Action: The addition of the following priorities for action is important in ensuring the financial and private sectors fully account for natural disaster risk post-2015.

-Access and apply knowledge, methods and assets from re/insurance and catastrophe risk modelling sectors to support disaster risk awareness and actions;

-Integrate disaster risk into general business education, professional development and training, as a fundamental commercial responsibility and duty of care to employees, customers and wider stakeholders;

-Incorporate disaster risk within accounting and management policies to support financial stability and inclusion;

-Ongoing evaluations of financial risk associated with disasters and assessment of resilience measures;

-Incorporate disaster risk rating factors in financial securities and asset classes including equities; sovereign, municipal and corporate bonds; property and investment funds.

Occasionally CDKN invites bloggers from around the world to share their views. These opinions do not necessarily represent those of CDKN or its alliance members.

Image courtesy Bonnie Rezabek, flickr.com