Tim Grafton: Take long view of risk management

People are often bad at managing risks that occur infrequently, such as floods or earthquakes, telling themselves "it could never happen to me". Photo / Brett Phibbs

Issues such as climate change mean we must look to the future — and soon

Managing risk matters. It's something our bodies do well. We sweat instinctively to cool the body when we exercise. Our "sixth sense" tells us to avoid threatening animals. What we don't do well is manage those things that occur very infrequently. We tell ourselves "it could never happen to me". Think earthquake and floods.

Imagine if there were 100 independent risks with a once in 10,000 years probability that any one of them would happen to you. You might well think none will ever happen, but you would be wrong. You should expect one of those to happen to you if you live 100 years.

It's almost never a case that something is too unlikely to go wrong. Rare things do happen because there are many potential risks, some of which can cascade on each other. Here's an example.

London insurers Lloyd's and Cambridge University have developed a credible scenario based on an extreme El Nino. It goes something like this - flooding in the Mississippi and Missouri rivers cuts US maize, soy and wheat production. A mix of droughts and floods in other parts of the world cuts the production of rice as well as those staples.

Overall a 7 to 11 per cent cut in global production of these crops results in their prices quadrupling to levels last seen in 2000. Food riots break out in the Middle East, North Africa and Latin America, stock markets lose 10 per cent of their value. Trade protection measures are brought in, plant pathogens spread due to climatic change, migration by economic refugees soars, pesticide is overused to counter low yields.

It is a scenario, granted, but one that the potential impacts of climate change makes more salient. Climate change is a risk management problem, meaning we need to limit the probability of a very bad outcome to an acceptably small value.

For any risk, whether it's to the government, the council, a business or an individual, it comes down to assessing the value at risk, the probability of a risk occurring and what protection you have for your assets. That last item is not a plea for insurance, though transferring risk to an insurer is part of the solution.

Transferring risk does not, of course, get rid of risk. So, protecting assets is as much about reducing risk before disaster happens. This is why we collectively need to take a long view so we can build infrastructure to protect against flood damage or decide not to develop where land is poor and vulnerable to hazards.

The recent report by the Parliamentary Commissioner for the Environment on sea-level rise identified $20 billion of assets within 150cm of the mean high tide. What that report did not do was model the impact of increased rainfall in some parts of the country. Nor did it analyse the quality of the ageing underground infrastructure's capacity to deal with high volumes of water. So, if anything, it understates the risks.

The Insurance Council has a 15-point plan in its position paper Protecting New Zealand from Natural Hazards, which is designed to ensure we identify the risks we face and act to reduce them if the cost-benefit analysis supports this.

We know every dollar spent on reducing risk saves many more after a disaster - without including the social cost and dislocation. Reducing risk helps keep the ability to transfer that risk to an insurer affordable. High risks are not ones that insurers are willing to take on, so risk reduction helps keep insurance accessible too.

Knowing what the risks are though has proved problematic. For instance, where councils have attempted to identify risks on publicly available Land Information Memorandums (LIMs), homeowners have reacted angrily, seeing this as a sure sign that their property value will fall and they may not get insurance needed to underwrite their mortgage.

Of course, censoring LIMs is like the proverbial ostrich with its head in the sand, largely based on misunderstanding. Insurers get information on property from a wide variety of sources and will generally respond on the basis of actual claims made. That's not to say they won't be alert to areas that, for instance, are more at risk from floods, but it's very unlikely to make them uninsurable.

Transparency about the risks is needed though, especially due to the incessant impact of climate change in some parts of New Zealand. The tide is rising on these issues, so we need to manage that risk better, not hide from it.

• Tim Grafton is chief executive of the Insurance Council of New Zealand.