Risk, Readiness and Resilience

Risk, Readiness and Resilience
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On February 17, 2016 Risk Cooperative, Lloyd's, the world's specialist insurance market, and American Security Project, a non-partisan think tank founded by John Kerry among others, unveiled the City Risk Index in Washington, D.C. This first of its kind event brought together leading authorities on risk and resilience from the military, public and private sectors for an in depth conversation on the geopolitical, economic and policy responses to a rapidly changing world.

One red thread held all of the expert commentary together - namely, there is no more time to search for causality of the host of man-made, natural and emerging risks imperiling our world. It is now time to act. In order to arrest and begin to reverse the negative trends eroding resilience in cities and countries, it is now time to pre-invest in resilience, going as far as making it an 'investment grade' asset class. Few sectors have the purchasing power, financial and modeling sophistication - along with a sufficiently long investment horizon - to achieve this than the global asset management and insurance industries, which sit astride trillions in assets under management.

An additional trend enjoying consensus among the expert participants, including Governor Tom Ridge, the first Secretary of the Department of Homeland Security and Judge Alice Hill, President Obama's chief resilience adviser at the National Security Council is that we are in a period of dangerous convergence between man-made and natural risk. This convergence calls for new approaches to long range adaptation and, above all, pre-investment at all levels of society in building resilience. Unfunded shocks to the system that are borne by tax payers not only increase the exposure to sovereign risk in already debt-laden economies, they misprice otherwise marketable risk creating a disincentive for adaptation while breeding moral hazard.

A moral hazard arises in systems where the downside of risk-taking is not borne by the risk-taker. In terms of adaptation to climate change, for example, government-backed flood insurance programs, many of which labor under solvency challenges, promote the reconstruction of 'brick and stick' buildings following a disaster. This is partly driven by the fact that the true cost of these risks are not borne by the communities that insist on rebuilding in flood plains, Tornado Alley and in coastal regions without major changes in building codes and materials. As Governor Ridge shared in his keynote address, resilience is not a destination, but a journey - one that requires constant course corrections and vigilance to emerging threats.

Cyber risk is one such emerging threat and the constant din of the 21st century wreaking havoc on critical systems, countries and individual companies with reckless abandon. Ridge Global, a firm started by Governor Ridge and leading experts in cyber resiliency, has waded into the cyber standards war with a compelling value proposition. While cyber risk is en vogue, we should not let the specter of a breach distract from equally urgent (but less 'sexy') long range investments in infrastructure and other systems. As argued in this article co-authored with Daniel Wagner, infrastructure is the veritable lifeblood of a resilient society and the U.S. is falling alarmingly behind.

Understandably risks of the smoking crater variety garner a lot of attention and therefore resources. Yet, insidious attrition of infrastructure, preparedness (think of New Orleans' levee system pre-Katrina) and degradation matter as much and are woefully disregarded. We are no longer in a "not in my life time" era when it comes to climate change, cyber risk and other emerging threats. The constant barrage of changes, evidenced by the number of alert letters consumers receive that their accounts were comprised serve as a daily reminder that risk is a surprise, but readiness and resilience are not. The IRS joins the long list of compromised organizations, with more than 700,000 records exposed.

Readiness and resilience mark the ability to preempt and spring back from unforeseen threats, whether they are acute or attritional in nature. We have to recall that the 2003 Great Blackout that sent much of the eastern seaboard of the U.S. and parts of Canada into darkness was not triggered by an act of cyber warfare, but by a rogue tree branch in Ohio. Complex systems fail in complex ways and often simplicity is our only countermeasure - like pruning trees. One thing rings true, it is now time for concerted action at all levels of society. The stakes could not be higher and the opportunity to build and preserve value by investing in resilience is our most important economic choice.

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