by Joseph Fiksel
The annual Global Risks Report published by the World Economic Forum has changed significantly over the years. It seems that our understanding of global risks keeps evolving—they are complex, highly interdependent, and difficult to quantify. Since Swiss Re is involved in producing this report, can you explain more about these challenges?
I’ve been involved with the Global Risks process during the last few years, and I think the key is to keep the dialogue going. The scope is enormous, and we realized that each year we have to focus on selected aspects. Given the high level of complexity and connectedness that you mentioned, it is best to dig deeper on certain aspects each year, and reserve the right to come back later to other aspects. We found that one of the major challenges is time scale. If your organization looks out over a five-year horizon, then many of the largest risks, such as the impacts of climate change, are unlikely to materialize in that time frame. For a risk to be relevant to decision makers, it needs to be within their time horizon.
Is the insurance industry as a whole responding somehow to this changing perception of risk, or is it just business as usual?
The world looks very different after the 2008 financial crisis, and I think that some of the key propositions of the Global Risks Report have been taken up by the insurance industry—more foresight, trying to be more holistic, and putting risks on the table that cannot easily be quantified. I think that there is more scenario thinking and an emergent use of “storytelling” in order to better understand the issue before jumping into action. And then, of course, you have the challenge that with some of these complex risks, none of the players—private or public—can tackle it alone, so there is an urgent need for collaboration. In certain times you need to meet short-term targets in order to survive, and it’s a huge stretch for the corporate world to take a longer-term perspective.
Yes, I have noticed that there is a lot more collaboration going on nowadays. Why do you say that they can’t do it alone? Why is it important for companies to work together on these kinds of macro issues?
The reinsurance industry is good at understanding risk, but when it comes to making a change we are at the end of the value chain. A reinsurance company does not implement any preventive actions. We are not issuing policies to homeowners nor putting zoning laws in place or enforcing building codes. Many different stakeholders have key roles to play in order to increase society’s resilience to natural catastrophes. Our role is putting a price tag on risk, thus providing transparency, and creating a fact base for decision makers that states: this amount of risk you can avoid, this amount you can better prepare for, and this amount is most economical for you to transfer or diversify. Only on the last piece do we actually write the business, so we have a keen interest in seeing that this risk “value chain”—these different elements in a holistic risk management approach—are taken up by the respective stakeholders.
How does Swiss Re define resilience, and how does it fit with sustainability?
Sustainability, for Swiss Re, in essence means taking a long-term view, and therefore sustainability is a guiding principle of the company. That means when we develop strategy, we ask the question: “Does it not only work for next year —will it also work five years, 10, or even 20 years from now?” We are even beginning to ask “it might work for us, but for whom might it not work?” We should be aware of it and we should at least mitigate the consequences or even revise the strategy if we believe that it is not truly viable for other stakeholders.
Then we started to realize that in many cases, risk management of the first kind—avoid it or build defenses against it—will not work. You need at least a dynamic approach to risk, and that was our initial interpretation of resilience—dynamic response to a challenge. Only in the last two years or so did we realize that resilience, the adaptive capacity of a system, also includes the ability to transform. It goes beyond buffers and spare capacity; it enables the system not just to react but actually to reconfigure itself in response to a shock.
As a physicist by training I come from a “complex adaptive systems” perspective. It’s one thing to study complexity, but in order for the system to survive, to respond to shocks, one should focus at least as much on strengthening adaptive capacity—i.e., resilience. This leads me to ask, “In such a system, where can reinsurance play a role?” That was the reason for us to engage so much on climate change because by putting a price tag on risks, we raise awareness for the issue and its complexity, and we incentivize prevention and preparedness. Prevention means primarily greenhouse gas emissions reduction; that’s why Swiss Re is carbon-neutral, and we have reduced our per employee footprint by more than 50% since 2003. Preparedness doesn’t just mean putting up higher barriers against floods but rather, thinking about how we should build and develop to be more adaptable to future events. In short, strengthen climate resilience.
How is Swiss Re integrating these ideas into its business?
Swiss Re has a five-year strategy built on a long-term outlook. We are mindful of these resilience concepts and we do employ scenario techniques to stress-test our strategies, but we are still wrestling with it. One area where we are relatively advanced is in the economics of adaptation—we look out 20 to 40 years into the future at emerging challenges and some of the defining changes that may happen. We try to describe the risk landscape of today, chart out economic development for the next few decades, develop scenarios of how the environment could change over that time scale, and then take it back to today’s decisions. We do so by comparing the potential impacts, i.e., damages, to the actions that you could take to be better prepared. We discount costs (the actions) and benefits (the averted damages) in order to make them relevant for today’s decision makers.
We have worked in more than 20 places around the planet to apply this methodology to different hazards, sectors, societies, and cultures. It is sobering that risks are increasing between 60% and more than 100% by 2030; this is due partly to economic development that puts higher values at risk and is further aggravated by climate change. But we have found that about 40% to 60% of the risk can be dealt with cost-effectively. It doesn’t mean that the risk goes away and adaptation doesn’t come for free, but it’s cheaper than just waiting for the impacts to hit us. We are still at an early stage, the methodology is constantly developing, and we are planning to apply it more broadly than just climate and natural catastrophe risks.
Do you think there is hope for us to eventually quantify the value of resilience improvements and perhaps even to influence how you make insurability decisions?
If you can define the system and its boundaries sharply enough, then you should be able to find a way to quantify the value of resilience. The problem is that in trying to come up with a precise number you might define the system too narrowly, and that would defeat the original purpose. I think it can be helpful to go at least some steps on this pathway to see what matters more or less. As I said before, if we at least give natural catastrophe impacts a price tag, it starts to make climate change and the world around us relevant to our decisions. But this is a very narrow framing of the problem because societal resilience starts with education, not with building dams.
From your experience with multinational companies, do you think that enterprise resilience is different from the conventional approach to risk? Does it represent a new element of enterprise risk management?
Swiss Re insures a large number of multinationals, in addition to our reinsurance business, and so we are well acquainted with enterprise risk management. I think that the concept of enterprise resilience has a liberating effect because it makes it more tangible for risk managers to think beyond the enterprise “fence line.” In essence, it helps them to embrace the boundaries of their influence and to think about how to transcend them.
For example, they might ask “What are the actions we can take, together with our stakeholders, to better manage risk for the system as a whole. It helps to involve the surrounding community before an event rather than afterward, and often it would really help if you increase their resilience in order to protect yours. This is a new concept to some, but the leading companies in the field are thinking this way.
Do you see evidence that there is growing awareness of this new way of thinking?
This is my hope, and I do see evidence in some pockets. One example is the work of the Resilience Action Initiative, a group of companies that are working jointly to investigate how we can improve the resilience of the system in which we operate. We’re currently working on a project to put a “resilience lens” on enterprise risk management. With that, we aim at bridging the gap between systems science and a risk practitioner’s approach.
Let me give you an interesting example of a climate resilience study that we’ve conducted in the Gulf of Mexico. Together with Entergy, an energy utility company, we’ve investigated how to flood- and surge-proof the company’s installations. We’ve realized that the real opportunity goes beyond avoiding damage; it is about being better organized to rapidly detect problems and to best serve their customers. This way, they’ll gain market share after the event, as it will take competitors longer to be back in business. It is not necessarily about protecting a substation; it is more about how you engage with customers to be prepared for an emergency. Serving a customer by bringing in a generator may succeed just as well as flood-proofing a substation, and may be a more economical use of resources. The question is “What helps to best serve the joint interests of both the company and its customers?” This study provided good insights into how companies can organize to weather these types of challenges.
So you are saying that resilience is not just about avoiding losses, but it is also a strategic opportunity for differentiation in the marketplace.
Indeed it is, that’s why we are starting to look at the transformative piece. It could well be that the energy utility business model shifts from selling power to providing a service. There are examples in California where a power company offers energy service contracts, where the customer simply says “I would like to get a certain quality of heating in my building, but I do not need to own my heating device.” The company might decide to hook up the neighborhood on a district heating system. This is a huge investment, but the contract model would allow them to amortize the investment. Meanwhile, the individual homeowner just cares about being warm in winter and cool in summer and does not need to know the means by which that service is provided.
We have a lot of challenges in the global economy, including stresses on natural resources, population growth, the desire to alleviate poverty, and rapid industrialization of emerging economies. From a global perspective, what do you think are the key factors that will enable the economy to become more resilient to future stresses and disruptions, including climate change?
This is a big question, but one important element that I see is to internalize known externalities.
We know quite a lot about this planet, and we are not acting on it. For example, putting a price tag on carbon will help us to better allocate resources. This is the low-hanging fruit, but we need political consensus to take action. The key players in the economy could make that happen, and many large corporations have already set targets for reducing carbon emissions, since they know it will eventually make economic sense for decision making.
Secondly, I think we need to recognize that the global economy is a means to achieve something. Do we (still) know what it is we want to achieve? Economic growth above a certain threshold of well-being becomes quite hollow or too narrow a proposition. I think it is important to strengthen the political process so that people can express their preferences as to what type of economy they want.
Are you suggesting that rather than blind pursuit of economic growth, there are different styles of economic models that may be suitable for different countries?
Blind pursuit of GDP growth is not really pursuit of happiness—perhaps, for some but not for everyone. We are working with scientists like Brian Walker to rethink what we really intend when we allocate resources and what set of values should guide our journey. In sustainability language we might say that we value environmental integrity. Resilience is more complex because we do not value a state but rather, an attitude. I think it may liberate us from the ideological discussions around sustainability.
Resilience is not just about rate of growth; it is also about the capacity to resist disruptions and adapt to change. Does that suggest some other factors that we need to work on?
It’s interesting—if everything runs super-smoothly, it quickly gets boring. The right level of disturbance for the switched-on brain, the way we are wired, is something what we seek. So the right level of turbulence should be perceived as a positive, healthy condition. The more you plan for turbulence, the more you improve your ability to deal with it, the more fulfilling is that experience. It’s tough because there are probably large parts of the global population that are not in such a relaxed position to muse about this. Only when a certain level of basic needs is being fulfilled can this be seen as positive.
If I may paraphrase, are you saying that for any living organism, it is healthy to have a certain level of turbulence and variety rather than a purely static condition?
Yes, and to take it a step further, under an egocentric, or “winner-takes-all” approach, it is much harder to deal with turbulence. The powerful winners may not be disturbed by turbulence and may not have a keen interest in helping those in more trouble. If you move toward a more collaborative model, then you can increase your resilience, and you can view turbulence as more of a positive challenge than a threat.
