Lloyd’s Science of Risk Prize winner - Accounting for business adaptations in economic disruption models.

The capacity for businesses to adapt in the face of adversity has been clearly demonstrated through the COVID-19 pandemic.  Actual economic losses and business closures related to COVID-19 have been significantly lower than projected, which demonstrates the inadequacy of our economic models to account for important contributing factors such as business behaviours.

This research is the first of its kind to build an empirically-derived model of business impact and recovery following disruption.  Using business impact and recovery data from the 2010–2011 Canterbury earthquakes (New Zealand), and qualitative validation, this paper presents a novel, transferable model for estimating business recovery following disruption. The business behaviours model (BBM) is a logarithmic function that calculates operability (ability to meet demand) over time based on 15 industry sectors and the level of experienced infrastructure (water, electricity, road etc) and non-infrastructure disruption (including supply, demand, neighbourhood, and staff disruptions). The BBM can be applied as a temporal adjustment factor to an economic model, or it can be used as a tool to explore the impact of different disruption types and magnitudes on organisation recovery. In addition to the model, the research provides a method for others to analyse and quantify business operability following a complex disruption.

The research has important implications for the insurance sector.  For insurers to maximise their capacity to support organisations (and economies) through crises and to design policies that optimise benefits to their clients and return reasonable profit to insurers, risk models need to account better for the capacity of businesses to adapt.  This paper provides both a method and a set of preliminary models that explicitly describe, in quantitative terms, how different sectors are affected by a range and combination of disruption types.  The BBM is designed for easy integration with a range of economic models.

The data collected in this research, and the BBM itself, could help insurers better understand the type and extent of cover that different sectors need so that policies are designed to map to key vulnerabilities.  The research clearly indicates the need to tailor business interruption insurance by sector, infrastructure dependence, nature of customer base etc.  This data is also useful for developing education material for clients on how to reduce business interruption losses.

The temporal aspect of business recovery explored in this research is also important.  Our research from the Canterbury earthquakes demonstrated that the benefit of insurance payments can be negated if they are not paid out in a time frame that supports the insured. The BBM can help insurers consider insurance policies or delivery models that inject capital at times that most benefit the insured.

In this paper we also introduce readers to MERIT. MERIT is a state of the art economic evaluation tool designed to imitate the core features of a computable general equilibrium model. However, it was formulated as a system dynamics simulation model using finite-difference equations.  This is an evolution in economic modelling of disruption that enables users to better understand the transition path from disruption to a new steady state.  Critically the ‘new normal’ state may look different to pre-event as the impacts of a disaster may change the balance of the economy.  This dynamic approach to modelling is becoming increasingly critical for understanding the impacts of complex events such as pandemics and climate change, where individual, organisation and sector adaptation is a core feature of the response to an event.  These types of crises often serve as a springboard to changed behaviours and our models need to incorporate these changes so that we understand the full economic impact.

The MERIT team’s research is challenging the status quo in economic modelling of disruption events.  It is a paradigm shift from static business as usual models, to techniques that capture and account for the evolution of an economy under stress.  We live in an increasingly volatile world with challenges such as climate change, technology advancements and globalisation that are changing the way we do business.  Every crisis and disruption shifts the dial further.  Consequently our economic models must be able to adapt too.  The MERIT model does this through the translation of a CGE model to a system dynamics framework that seeks equilibrium but is not set to an equilibrium.  The BBM is a vital input to MERIT.  Without understanding the behaviour of businesses under stress, we will not be able to truly understand an economy under stress.