The number of megacities around the world is increasing. More than 40 are expected by 2030, compared with 18 at the beginning of the century, with this trend a particular phenomenon across Asia. Such highly interconnected, dynamic and vibrant centers are predicted to contribute higher income and living standards for their citizens. However, they also pose a number of new challenges, which society will need to address and find solutions for.
This Allianz Global Corporate & Specialty (AGCS) report examines how natural catastrophe, pandemic outbreak, terrorism and cyber risk could potentially affect megacities in future and provides insight into the different ways in which the insurance industry will be impacted.
Growth in the number of megacities – urban areas exceeding 10 million inhabitants – has been a remarkable recent phenomenon. In 1950 there was just two - Tokyo and New York. By 2000, this had increased to 18. Today, there are 29 megacities, with the majority (16) located in Asia.
Megacities matter today but will be even more important in future – their number is expected to grow to over 40 by 2030. Such megalopolises show where urban development is heading and how transport, energy, culture and economies can be organized but extreme concentrations of people also cause big challenges, for which insurers and other stakeholders need to offer solutions.
Natural catastrophe risks
Earthquakes, cyclones and flooding are the major natural catastrophe perils threatening megacities. While the likes of New York, Paris and London achieved megacity status through growth over centuries, the enormous speed of urbanization displayed in Asia leaves developers in low- and middle-maturity megacities without the time and means to develop appropriate natural catastrophe protection and business continuity plans for when disaster strikes.
In 2013, a World Bank study on flood related losses predicted a potential increase to $1trn by 2050 from $6bn in 2005 if the growing threat is not efficiently countered[i]. The World Bank names Asian coastal megacities as being most affected. Meanwhile, a review by Aon Benfield of the 2015 top-10 economic losses inflicted by natural catastrophe shows that underinsurance or low insurance penetration still prevails in Asia. While the region suffered more than 90% of fatalities and almost 70% of economic losses, insurance recoveries accounted to less than 15%.[ii]This picture, however, will change rapidly as prosperity and insurance penetration for Asian low- and medium-mature megacities increases.
Businesses in megacities will continuously seek enhanced protection for their increasing values at risk. Natural catastrophe exposures will materialize inside of megacities through property damage to assets, for example, factories, and connected business interruption (BI) as well as contingent business interruption (CBI), which will be triggered under suppliers and customers extensions. Supply chain dependencies create a systemic risk in the global economy. They are difficult to measure since often losses are incurred a long way away from where the natural catastrophe strikes. A consultative approach and dialogue between insurers and insureds is needed to fully understand and gauge the exposure.
Realistically, natural catastrophes will continue to be a major threat to Asian megacities. However, the experience accumulated over decades, the improved modeling capabilities and especially the successful collaboration between insurers and governments give reason for optimism.
The vulnerability of megacities to the threats posed by pandemics was seen in 2003 through the spread of the Severe Acute Respiratory Syndrome (SARS), an extreme form of pneumonia. Within a short time span, the SARS virus, which originated in mainland China, was transmitted via air travel from Hong Kong to numerous Asian megacities like Beijing, Tianjin and Shenzhen and other major cities like Hanoi and Singapore. In 2016 medium-mature megacities in Greater China may be better prepared for the outbreak of infectious diseases. However, low-maturity megacities like India’s Mumbai and Delhi or Bangladesh’s Dhaka with an estimated 20% to 30% of city housing located in poorly sanitized slums[iii] will still be primary victims of pandemics.
Determining the potential impact of a pandemic on a megacity requires actuaries and modelers to work with new scenarios. These models need to address the reality that larger concentrations of people place more people at risk of exposure to infectious diseases. In megacities with a smaller footprint like Hong Kong, the risk of spread is increased due to high concentrations of residents in more confined space. Immense health care costs will be associated with a single event in a megacity.
Pandemics can cause large claims to property insurers under the coverage extension “denial of access” or “infectious disease”. Megacities do not only hold important manufacturing sites, but also headquarters of leading companies, stock exchanges and data-centers etc. Following the outbreak of an infectious disease, denial of access to a metropolitan business center can potentially paralyze large parts of the economy. The emerging megacity forces insurers to constantly measure the exposures of businesses, which potentially arise through manufacturing supply chains.
Quality standards of health-critical infrastructure, in particular, sanitation and sewage facilities can increase, or even cause, the spread of infectious disease. Degradation of facilities and a subsequent pandemic outbreak, will potentially give rise to third party claims against semi-public or private infrastructure owners and operators. It would be negligent of insurers to discount the risk arising from third party liability in a growing megacity. In particular, the growing upper-and middle-class, will expect higher compensation and potentially fines to be paid for pandemic-related damages.
In future, technological advancement might bring some relief to insurers as well as authorities. For example, newly-developed 3D printing techniques could offer solutions to swiftly build mass-housing facilities in times of crisis, moving citizens out of infested areas.
Terrorism and cyber threats
Conventional terrorist activity has risen in recent years. Densely populated megacities offer attractive targets in the form of landmark buildings, high-value assets, and central points of human interaction. A lot of thought has been given by researchers, as well as metropolitan and federal governments about how to identify and minimize the impact on megacities from conventional terrorist attacks. Working in a complementary manner with authorities around the globe, the insurance industry provides a well-established insurance product with a clear definition for trigger and coverage. The well-established market for terrorism insurance in combination with government-backed pools gives some peace of minds of risk practitioners during a time of increasing uncertainty.
In addition, the increasing and ever-evolving threat posed by cyber risk, and its potential for subsequent damage, concerns insurance and business leaders. For a city, the impact of a cyber-attack is correlated not only to its size but also to its degree of decentralization and “smartness”. Megacities differ from smaller cities, not only in their enormous size and high growth rates, but also in both the depth and the range of their resources and the complexity – i.e. the smartness – of assuring the reliable functioning of all services. For megacities, generally all three correlation parameters, i.e. size, decentralization and IT-based smartness, are – with high likelihood – aggregated and can create an explosive mixture.
Newer smart developments are, for example, waste management, street lights, or the smart grid, which manages energy production in real-time under the aspect of supply demand and cost-efficiency. The scenarios deriving from a potential attack on a smart city are multifold and of differing impact. While dysfunctional waste management can create a difficult situation, a breakdown of a city’s CCTV system due to a cyber- incident could severely cripple its strategy for counterterrorism, for example. A power-outage following an attack on the smart grid is a worst case scenario.
Asia’s varying economic development stages are reflected in its megacities in terms of maturity and “smartness”. Tokyo, as Asia’s most mature megacity, relies heavily on IT-based solutions for its inhabitants; for example, sensors, cameras and smart meters steer traffic, maintain security and manage electricity consumption. Low- or medium mature megacities in Asia utilize IT to a lesser extent and are subsequently less exposed to cyber-threats. However, their vulnerability will increase starting with the area of public transport. Newly-commissioned Mass Rapid Transport (MRT) projects will make capitals like Jakarta, Manila, and Bangkok increasingly smart.
Protecting IT-dependent megacities is one of the greatest conundrums authorities and insurers face. The industry is employing experts for scenario planning and modeling. As a result, the broad impact of a potential cyber-attack has become, to some extent, more quantifiable. Insurers are also in the process of expanding coverage, reducing ambiguity and building up risk management capabilities.
However, the technical sophistication of cyber- attackers, their capability to specifically target critical infrastructure and the relatively small available loss experience to date remain major concerns. Considering the size of the cyber-threat in rapidly growing megacities, regular expert dialogue sessions, in which authorities exchange details about the latest cyber risk trends on a confidential basis with insurers, brokers and other leading companies are needed, establishing a “big-data approach” to cyber-risk. In future, this knowledge exchange will be crucial in enabling adequate pricing and developing best practices in cyber underwriting and risk management.
Wider insurance impact
Assessing the megacity’s impact on the insurance industry is a fascinating challenge. In a megacity, where there are aggregations of business and personal consumers, many different forms of distribution or buying groups may emerge, whether formed by an insurer or intermediary, or self-formed because of proximity. For example, the residents of a 60-story condominium could form a buying group solely for the purpose of sourcing their domestic insurances and take their proposal to insurers to negotiate the best deal. For insurers, the opportunity is to recognize the potential that exists within a megacity and develop products and services that meet needs and lower costs because distribution is more efficient.
The continuous emergence of the megacity could have a significant – potentially threatening – effect on motor insurers. Efficient public transport will become more readily available - especially in Asian capitals in the form of mass rapid transit (MRT) systems. The notion of car sharing may develop further. The combination of improved public transport and a rising share economy could reduce the number of insurable cars and premium pool of motor insurers. Innovative megacities, which usually struggle with congestion, will also be at the forefront of putting automated driving into practice. It can be assumed that human error, the major cause of vehicle accidents, will be reduced, leading to fewer claims for damage and injury.
However, if an accident does occur, the likely scenario is that the manufacturer of the vehicle – or possibly the vehicle’s maintainer – will be liable for compensation. Therefore, public- or products-liability related claims may increase. There could be a time-lag before adequate modeling and pricing can be determined. In the meantime, will insurers simply exclude cover for these vehicles, or will the price of insurance be prohibitive. The challenge needs careful consideration.
Insurance as a concept and as a product developed over many centuries. One lasting principle is risk sharing by many. In the megacity, where the risk landscape is considerably different and constantly evolving, it is time to revisit the sharing concept. Public-private risk-sharing partnerships between the insurance market and the government can be effective in overcoming the impact of natural catastrophes, as shown in the Thailand floods in 2011.The same applies for a pandemic-induced crisis, as well as combatting the threat of traditional terrorism, where government-backed pools and a dependable insurance product aid the current critical situation.
[i] The World Bank, 2013
[ii] Aon Benfield, 2016 P2, Latest reports from Sri Lanka’s flood losses again underline the notion of severe underinsurance in Asian emerging countries
[iii] The World Bank, 2015