THE BLOG
12/21/2015 03:56 pm ET Updated Dec 21, 2016

Cities@Risk

Since the turn of the century, more people live in cities than in rural areas. This profound shift in human habitation heralds a new era - one rife with opportunity, new risks and changes in human adaptation. The era of homo urbanus, urban man, concludes the inexorable rise of cities as the nexus where civilization, trade and the global economy meet. Today, 301 cities comprise more than half of all global economic output. By 2025, these same cities are expected to account for two thirds of the world's Gross Domestic Product (GDP). In short, these cities are not only the linchpins of world history, they are themselves the protagonists of yet untold stories of how we thrive or decline in the next century.

In some cities, planners have made long range urban development a part of their growth strategy. From orderly capitals like Paris and Washington, D.C., to a sprawling metropolis like Rio or Mexico City, how urbanization and humanity continue to merge has profoundly shifted our story on earth. All cities, north and south of the equator, rich or poor are feeling the strain of a changing risk landscape and resource demands from being the target of both human migration and emerging threats.

A Tale of Two Cities

While cities in developed economies often groan under the strain of congestion, they are generally orderly places with vibrant economic activity. By contrast, cities in emerging economies often struggle to supply basic services to their densely packed inhabitants and even basic infrastructure, such as roads, utilities and other public works struggle to keep pace with demand. This strain is projected to grow exponentially through 2030, where our relentless drive towards urbanization will see no less than 41 megacities around the world - each home to more than 10 million people. Of these, 90% will be in developing and emerging countries. Large cities with 5 to 10 million inhabitants will continue to proliferate, tilting the scale of not only urbanization, but market demand away from advanced economies. While urbanization will continue to strain resources, it will also be the crucible through which human ingenuity builds a more resilient future. This resilience depends on enduring public sector leadership combined with market-driven private sector solutions. As seen at the conclusion of climate talks in Paris, which heralded a rare act of unanimity among the world's political leaders, change is afoot and people are recognizing the urgent need for greater resilience. Different from risk, resilience is something we must pay for in advance, rather than treat like an economic surprise.

Cities in the Crosshairs

In new research carried out by Cambridge on behalf of Lloyd's, the world's most innovative insurance market, an in depth analysis of 18 city-level threats was carried out producing the City Risk Index. Globally, economic shock remains the chief peril identified in this research, highlighting the risks from an interconnected, high-speed global economy. Beyond economic shocks, like those still reverberating from the 2008 Great Deleveraging, other threat categories are beginning to surface with increasing frequency. Cambridge researchers coined the term GDP@Risk to capture the share of economic value at risk should any one of the 18 threats emerge in a particular city. Similar to the concept of value at risk (VaR) seen in banking, this metric offers a valuable framework to political and private sector leaders alike. It reduces often complex and amorphous "not in my lifetime" risks to an understandable measure of what economic value is at stake. Beyond measuring economic losses should a certain threat emerge, GDP@Risk establishes a benchmark for what type of capital reserves may be required of the system in order to create more resilience.

Thinking of GDP@Risk, some recent examples offer sobering insights that city-level threats are not some remote reality dreamt up by grim risk practitioners, but rather a very real part of the world we live in. The 11/13 terror attacks carried out in Paris certainly reflect the city-wide paralysis that occurs following mass casualty events. A more insidious example of city-risk was the lengthy lockdown of Brussels as security agencies pursued the perpetrators and accomplices behind the Paris attacks. Brussels is the seat of power of Europe's collective government and the eerie stand still is an ominous portent of how simply a major city can be paralyzed. Beyond the fear of terrorism, a city's economy can grind to a halt from other threats.

The 18 threats identified in the City Risk Index can be categorized as natural, man-made and emerging risks. Overall, the Index offers a taxonomy of how to think about emerging threats. Of them, climate change is rearing its face as a very real and present danger. From hurricane Katrina, which inundated New Orleans, one of America's most iconic cities, to the first ever smog red alert that shutdown Beijing. City managers are responding with increasing frequency to natural events exacerbated by man that are entirely out of our control. Record snowfall in Boston exceeding 108 inches in the winter of 2014, for example, brought this usually stout winter-ready city to its knees. On September 27, 2015 Paris halted all vehicle traffic in the city due to lingering air quality issues. Often city-level events emerge due to under-investment in infrastructure, as we saw in the 2003 blackout, which was the largest such event in North America and triggered by accident.

The City Risk Index offers new insights into how long range threats and urbanization intersect. Looking at the 35 North American cities in the Index, the top 5 threats imperiling $616 billion in GDP are market crash, oil price shock, cyber-attack, flood and human pandemic. What is true of these types of complex risks is that they rarely confine to clean, discernible domains and they often interact with one another. For example, a terrorist attack or cyber warfare against critical financial systems can trigger economic shock, just as natural hazards can have spillover effects into other domains. The complexity of these emerging threat categories, along with others that are not in the Index, such as war, requires the development of new solutions boosting city-level resilience. Through this patchwork of resilient cities, a resilient country and in turn a more resilient world can emerge. As with all risk, the threats highlighted in the Index should be thought of as being both acute and attritional in nature. Just as Detroit's slow demise caused by a shift in manufacturing output felled this once great industrial city, cities often suffer large-scale as well as slow burn events.

A Roadmap to Resilience

Looking at the U.S. for example, certain challenges emerge when gauging city-level resilience and, therefore, national readiness in the face of critical risks. The strength of a Federated system like the U.S. lies in the whole being greater than the sum of its parts. During the last decade of partisanship in Washington, D.C., however, the whole appears increasingly unable to form a consensus on how and if to respond to a changing world - let alone act with the type of leadership these emerging threats require. Thus, power and the ability to respond to risk has in many ways devolved to the state and city level, where individual roadmaps to resilience are being charted. Of the risks threatening North American cities and, indeed, cities in diverse regions of the world, the majority fall into the man-made domain. Man-made risks contribute 62% of the GDP@Risk in North America, and nearly 50% of the risk contribution for the 301 cities in the Index. This confirms that the 21st century is in every way the era of man-made risk.

Resilience is an outcome not an aspiration. It is established first through a recognition and respect of risk. Second it requires concerted action to build redundancy in critical systems, while at the same time buttressing financial reserves to absorb shocks. The first lines of defense are the insurance companies that cover a wide array of conventional risks to assets, liabilities and lives across the world. Lloyd's research found that a 1% rise in insurance penetration corresponds to a 22% decrease in the financial burden passed on to tax payers following a loss. Once an insurer's reserves are exhausted, a rare but not unlikely event, the next tier of liquidity in heavily regulated financial markets like the U.S. are the state insurance guarantees. These funds are pooled in each state and generally administered by state-level insurance regulators. Looking at the types of city-level threats highlighted in the City Risk Index, the liquidity of state insurance guarantees would quickly evaporate, as would have been the case in post-Katrina New Orleans had Federal assistance not been granted. While solutions exist to harness the capital markets in response to catastrophic losses, such as catastrophe bonds, these instruments are generally attached to single risk domains, such as wind storms, and not a broad basket of city-level perils.

What is clear, our world is changing with increasing speed and capriciousness. We are entering a time when quantitative methods matter as much as our ability to decide with uncertain outcomes - a time where individuals and our choices are shaping the course of history in profoundly new ways. From cyber risk to climate change, how we build resilience depends as much on our technical mastery of risk, as it does on the micro-level choices of individual adaptation. More cities with cyclists, for example, translates into lower CO2 emission and faster egress from a city under threat. The City Risk Index makes a clarion call for greater integration of financial solutions, of which insurance is a part, along with better awareness and prevention of what is at stake in these times.