Control Climate Risk

  • Kevin Ingram executive vice president and CFO, FM Global, CFO; August 16, 2020

Even if the climate is beyond control

A hurricane striking the U.S. and a wildfire raging on the West Coast recently presented what The New York Times called “a preview of life in a warming world and the steady danger of overlapping disasters.”

Although no individual meteorological event can be solely attributed to a changing climate, trends in weather patterns continue to be unpredictable. Flood risk has increased in some parts of the world due to precipitation changes as well as sea-level rise while wildfires have been more numerous as a result of extended droughts. Global leaders are taking notice. For the first time in the World Economic Forum’s 10-year outlook, the top five global risks in terms of likelihood are all environmental.

Although the climate seems monolithic, climate risk is local and absolutely manageable. Climate risk is the potential adverse financial impact of climate-related disruption. Addressing it is imperative. And the senior financial executive’s responsibility isn’t abdicated because a pandemic is dominating attention.

Insurance isn’t enough

Property insurance is necessary to transfer climate risk in a large business but not sufficient to fully address it. Although a good insurance policy will cover the immediate property and revenue loss in a disaster, the financial impact of a disruption can endure long after coverage for an event has concluded. Nothing can fully replace lost market share, growth and investor confidence.

Even if you eventually recover from a disruption and return to prosperity, you still have lost discrete growth opportunities. A year of struggle after flood or hurricane damage can be like withdrawing your money from a high-yield investment for that period of time. When you reinvest, you will not be compensated for what you missed while uninvested.

Shareholder value at risk

Researchers have tried to measure some of these enduring losses. 

Consider flood, for example. An independent analytics advisory firm we commissioned recently looked at 71 large publicly traded companies that had reported financial damage in their 10-K statements from a major flood event in recent years. Twelve months after the event, their shareholder value had declined by an average of 5%, equivalent to a collective US$82 billion. Other companies surely experienced the same events but did not have to report financial damage.

This loss in shareholder value is a relatively new phenomenon. Shareholders used to give companies a pass on natural hazard damage, attributing it to bad luck. The relatively new shareholder value penalty is a sign that companies that fail to prevent damage lose shareholder confidence. Organizations are now expected to be resilient, and rightfully so.

We saw more evidence of how resilience works in hurricane research we commissioned last year. The shareholder value of companies that had implemented all of our storm-protection recommendations prior to hurricanes Harvey, Irma and Maria outperformed those that hadn’t finished doing so by 10%.

Not every company has acted accordingly. More than 3 in 4 (77%) CEOs and CFOs of the largest companies in the world recently acknowledged that their firms are not fully prepared for the adverse financial impact of a changing climate. And more than 8 in 10 (82%) believe their companies have somewhat to no control over such an impact on their business.

Controlling what you can control

I believe you do have control over climate risk.

Although the future of the climate is uncertain, natural hazards are the same ones businesses have faced for centuries: flood, wind, drought and fire. Businesses know–or can find out–how likely they are to experience these types of disruptions, how severe they might be, how they could affect their bottom line, and how to cost-effectively engineer resilience into their operations. Climate risk is a traditional natural hazard risk, just in a different package.

To address it, your team needs to assess, quantify and mitigate the threat.

Assess – I’d suggest ordering engineering reviews of all of your properties to fully understand vulnerabilities to water, wind and fire. With flood, for example, someone needs to understand how much water you are likely to get, how rapidly it will flow, in which directions, how long it will linger, and what contaminants it may introduce. Flood risk maps can help. 

Quantify – Look at every potential loss and estimate the cost in terms of replacement, repairs, revenue and business value. Calculate every site’s contribution to your profit. Now you can prioritize mitigation steps.

Mitigate – Use your financial analysis to determine most cost-effective ways to protect your profit. Mitigation can range from temporarily elevating critical equipment when a nearby river is rising or deploying inflatable dams to rebuilding an entire division at a less vulnerable site.

Finally, create an emergency response team that can develop sufficiently detailed emergency response plans and defined triggers to activate them. These plans are good to have for all hazards, including those unrelated to climate, such as an earthquake, chemical spill or disease outbreak.

With a strategy like this, you’re far less likely to fare poorly in a natural disaster, whether directly attributable to climate or not. You’re less likely to need to report financial losses, be punished for that in the stock market or have to explain the reasoning for your organization’s lack of preparedness to your company’s board of directors. 

Although the climate is a global phenomenon, the risk is very local. It’s focused on your property and your investment. And you have the control.  

As originally published in CFO


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Related content:

CEO/CFO Climate Risk Survey Results: How prepared are top firms?

Keeping Pace with Climate Change: Some insurers are better at understanding the potential consequences than others

Download resources in FM Global’s NatHaz toolkit