24 AUGUST 2023
How are cities preparing for and rebuilding after natural catastrophes?
The urbanisation trend is set to continue for at least the next 25 years. The fundamental reason is that cities are more financially efficient than rural areas. Each year more people move from the country to the city and, therefore, economies grow even faster. This migration is positive from an economic point of view but it also accumulates increased risk. Cities tightly pack so much value in one specific geographic area, and a single event can have a considerable impact in terms of loss.
Bigger cities, bigger losses
Consider hurricane activity in North America. Since 2017, the US has endured an average of 15 natural catastrophe events per year – compared to 10 in the previous decade and six prior to 2007. Last year saw the continued trend for increasing losses, resulting in USD 65 billion in insured losses and overall losses of around USD 110 billion across five states, making it the third-most expensive season to date. The period witnessed 14 named storms, with eight reaching hurricane status and two becoming major hurricanes (category 3 or higher). This was above the long-term average for 1950–2021 (12.2 named storms, 6.4 hurricanes and 2.7 severe hurricanes), but it was below the average since 1995 for a storm-active warm phase in the North Atlantic (15.7 named storms, 7.7 hurricanes and 3.6 major hurricanes).
Climate change has increased the frequency and severity of extreme weather, but there is another reason behind these rising costs: people choosing to migrate to coastal US cities, increasing the number of homes, businesses and buildings in the line of fire. Property development in cities most at risk of hurricane damage also erodes natural barriers that would otherwise help protect coastal areas from the storms. In Florida, wetlands capable of absorbing storm surges and rainfall have been swapped in favour of palatial coastal properties.
Florida has a Division of Emergency Management, which plans and responds to natural and man-made disasters. The division created the Hurricane Loss Mitigation Programme, which aims to minimise the damage caused by hurricanes. With an annual budget of USD 7 million, the programme funds property resiliency through retrofits made to residential, commercial, and mobile home properties, the promotion of public education and information and hurricane research activities.
A tale of two cities
Two types of cities are affected by extreme weather. Australia is heavily exposed to wildfires but, like North America, its major cities have the resilience and ability to innovate aggressively to deal with these problems. Although natural catastrophe events are associated with volatility, these are long-term exposures, and the data available today means that cities prone to natural catastrophe events and climate change are well aware and in a good position to adapt over a set timeframe. Local authorities have the regulatory and legal structures to meet these demands. In short, Australia’s major cities are wealthy enough to adapt; as Future Cities Winners and Losers Sydney case study illustrates, it’s Smart City Strategic Framework and “Resilient Sydney” programme aims to embed long-term heat resilience into urban planning and development.
Conversely, upwardly mobile cities are urbanising very quickly, have rapidly growing economies and are also heavily climate exposed. These cities don’t necessarily have the economic resources to adapt to climate change like their mature counterparts. Karachi is Pakistan’s financial capital, home to roughly 18.61 million people, and it is climate exposed because of its ocean. The city experiences extreme heat and is at high risk of flooding; in August last year, the city was flooded with monsoon rains. Even though there is some individual wealth in Karachi, the nation-state is weak, and affluence is not spread sufficiently to enact meaningful climate adaptation. Yet the city is growing at an exponential rate – in the last 20 years its population has increased by nearly 40% -- and therefore the risk a major climate event poses is also increasing.
What role can the insurance industry play?
Understanding climate exposure across cities is a huge endeavour for insurers and the importance of data cannot be overstated. Unfortunately, the data for upwardly mobile cities tends to not be as detailed or reliable as mature cities, especially for natural catastrophes.
Miami is heavily exposed to rising sea levels and became the largest potential maximum loss in 2020. In Miami, individual property developers will design climate adaptation measures for new buildings. For instance, they will lift the whole building above what they estimate will be regular flooding levels in 20 years’ time because they want to protect their investment. Therefore, in mature cities, the economic incentives for climate adaptations already exist. In comparison, a USD 3.5 trillion gap exists between current infrastructure investment in developing countries and what is required to ensure climate resiliency. This creates a politically unpalatable gap where cities in developed markets become less climate exposed as they have the means to adapt and poorer cities’ climate exposure increases as they are unable to manage this risk.
Undeveloped insurance markets make it challenging to secure long-term, fixed-price insurance for developments, and investors can be wary of financing projects due to uncertainty over the impact of climate change and the potential political risks involved.
The situation has the potential to worsen over time unless a solution for supporting lower-income climate-exposed cities is rolled out. How does the insurance industry incentivise cities to invest in climate adaptation measures? If Karachi takes out a loan to build flood defences, its climate risk will have dramatically reduced. How can insurers provide the city with credit over a longer timeframe and reduce their premium? What mechanisms exist to connect climate change investment with longer-term financial relief?
Financing resilience
In 2018 Lloyd’s of London partnered with the Centre for Global Disaster Protection, Risk Management Solutions (RMS) and Vivid Economics to produce a report, Innovative finance for resilient infrastructure, which explored the questions above. The report recommended four financial tools to improve resilience: insurance-linked loans, resilience impact bonds, resilience bonds and resilience service companies. It concluded that further work was needed to make the four products applicable for real-world use.
In 2020 the United Nations Capital Development Fund (UNCDF) brought together the working group Climate Insurance Linked Resilient Infrastructure Finance (CILRIF) to collaborate on a comprehensive climate insurance product for stakeholders in developing countries.
The consequent solution is a long-term “known price” insurance offering that aims to offer cities affordable, 10-20-year climate insurance with pre-arranged premiums – contingent upon the cities’ commitment to invest in climate resiliency.
If a city executes the adaptation measures set out in the insurance policy, the premium will decrease to reflect the managed risk. The initial target cities for CILRIF are Durban, South Africa and Makati in the Philippines, focusing on riverine floods. The next near-term target city is Freetown in Sierra Leone, which focuses on extreme heat.
CILRIF aims to support cities in building climate resilience via:
- structuring the insurance policy for long-term coverage with pre-arranged premiums
- incentivising follow-through on resilience building through a results-based premium pricing structure
- offering finance for resilience building through the financing facility
The intention is that the pilot projects will pave the way to the product being replicated on a global scale. Yet the path to progress is not without its hurdles. As CILRIF member and Munich Re Senior Manager, Origination, Michael Roth points out, there are reasons why these products don’t exist yet; therefore, bringing together so many different perspectives to meet this challenge is a necessary and pivotal step to insurance helping to close the climate adaption gap and changing the dynamics for future cities.
