Finding “Alpha” in Resilience

By Dr. Jeffrey Bohn, Chief Strategy Officer, One Concern

Well-designed and extensively deployed insurance builds societal resilience in the face of natural disasters, providing individuals, organizations, and communities the means to recover faster. But, unfortunately, the protection gap between the insured and uninsured continues to widen — reaching a high in 2020 of USD 1.4 trillion, according to the Swiss Re Institute.

Climate change is a primary driver of the protection gap, making it more difficult for organizations and communities of all sizes to cover the burden of uninsured economic losses. For example, on average, flooding in the U.S. causes USD 19 billion of losses each year, of which 74% stems from uninsured loss.

While most businesses want to buy business interruption insurance (BII), the challenges that hinder reducing the insurance protection gap primarily arise from insurers not providing reasonably priced coverage. Failures in reducing the protection gap can occur from the lack of granular models that make it uneconomic to underwrite BII risk for smaller businesses. As a result, most small companies and many medium companies cannot find reasonably priced BII.

Furthermore, data collection, curation difficulties, and underperforming, predictive BII models (probably related to climate change changing risk profiles), cause insurers to reduce available insurance capacity in the BII space.

One critical challenge to consider is that BII typically covers only business hardships resulting from direct property damage. Businesses want coverage for any disruption regardless of whether their property suffers direct damage. However, disasters often damage the networks a business depends on, such as power grids and transportation systems, leading to substantial economic losses.

As a result of these three challenges, insurance policies are often inadequate, don’t cover the full range of risks, or are simply out of financial reach for many small and medium enterprises.

Before joining One Concern, I worked at Swiss Re, one of the world’s largest reinsurers. As a result, I have seen from the inside the lack of granular, comprehensive, and comparable resilience statistics that can facilitate wide-ranging catastrophe-risk mitigation and related risk transfer. Moreover, climate change scenarios are typically not integrated directly into existing risk models, given the lack of granular resilience statistics — we at One Concern address this gap.

One Concern’s business strategy leverages data and machine intelligence to measure resilience to natural disasters, resulting in a resilience score that measures the likelihood that a particular natural catastrophe (e.g., hurricane or earthquake) disrupts the normal use of a commercial property. This resilience score also estimates that property’s operational downtime — measured in hours to days — associated with a particular catastrophic event. The result is a resilience score, which facilitates better risk assessment for climate-change-induced natural disasters by providing the analytics to adjust valuation models for resilience. Furthermore, proposals for risk mitigation can now be subjected to an objective return-on-investment assessment that accounts for climate change and resilience to natural catastrophe risks. These analytical tools make risk management more accurate and effective. Our goal is to become the de facto global standard for measuring resilience as a standard for mitigating risk.

In summary, One Concern is developing a resilience score that reflects catastrophe risk in ways that link property and business valuations to the full range of low-probability, high-severity disruptions, especially natural disasters exacerbated by climate change. One Concern’s resilience score and related resilience statistics provide One Concern’s clients a first-mover advantage as asset valuations begin to reflect differentiated resilience. As observed in other environmental contexts, market participants who incorporate new analytics to capture a differentiating valuation driver — before the driver is widely reflected in market prices — can potentially find positive alpha strategies.

Today, One Concern can assist interested market participants in seamlessly adjusting their current valuation and risk management models for resilience, creating resilience-adjusted valuations (RAV). This approach can facilitate substantially improved hedging, mitigating, managing, and transferring of catastrophe risk. We anticipate resilience exchanges will develop on the back of resilience scores and RAV.

In the meantime, first movers will likely generate higher risk-adjusted returns in properly constructed resilience-focused portfolios.

Dr. Jeffrey Bohn is Chief Strategy Officer for One Concern and a Board Member of the Consortium for Data Analytics in Risk (CDAR) at U.C. Berkeley.