Climate Change’s Growing Impact on Property Coverages
Risk managers don’t need to be reminded of the threat climate change poses to their organizations. The latest headlines do a fine job on their own. When every week seems to bring news of more tropical storms, encroaching wildfires, floods and other natural catastrophes linked to global warming, the challenge for risk managers is to translate all of these signals into strategies to help reduce their organizations’ exposures.
These efforts fall broadly into two categories:
- Implementing a rigorous environmental, social and governance (ESG) program and communicating progress to external parties
- Using modeling to gain a greater understanding of future exposure to climate change
Meeting the Baseline for ESG
UN Secretary General Kofi Annan introduced the concept of ESG in 2005 as a way to champion socially responsible investing. As issues related to ESG have been elevated in importance, more and more companies have reported on their progress as a way to satisfy investors. However, other stakeholders also have heightened expectations.[1]
A Top Priority for Companies
Many companies are actively engaging in ESG activities and monitoring and reporting on those activities. The growing effects of climate change have increased pressure on corporations from investors, employees and the general public to become part of the solution. A recent survey found 91 percent of executives believe their companies have a responsibility to address ESG. ESG is also a priority for 86 percent of employees and 83 percent of consumers.[2] Whereas ESG used to warrant only a passing mention on analyst calls, business leaders now spend as much as one-third of their presentation on these topics.
The regulatory environment is also compelling companies to report on ESG. Europe has been at the forefront for some time, but U.S. states such as California, New York and Vermont are actively pursuing a similar regulatory mandate around disclosure. The Canadian government doesn’t specifically mandate ESG disclosure, but entities such as Ontario’s Capital Markets Modernization Taskforce have called on the Canadian Securities Administrators to do so.[3]
Every company is at a different point in its ESG journey as measured by planning, monitoring and reporting. Some large companies are taking a more proactive approach, including making public statements regarding the use of energy, water and other resources.
The taskforce recommends mandating disclosure of material ESG information, specifically climate change-related disclosure that is compliant with the TCFD recommendations for issuers through regulatory filing requirements of the OSC.
Access to Property Coverage
This scrutiny on ESG has had a knock-on effect: Companies, particularly those in fossil-fuel industries, must increasingly meet a baseline on ESG to maintain access to the capital needed to support growth as well as coverage in risk transfer markets. In the current business environment, some of the influence of the frontline underwriter, CEO or CFO has been eclipsed by the investor community, which expects companies to take the lead on environmental issues.
The oil and gas sector has been under scrutiny for some time, and its response can serve as a point of reference for companies in other industries. Certain projects and operations, such as mining Canadian oil sands or running coal-fired power plants, have fallen out of favor with investors and thus have affected the ability of companies to retain property coverage in those areas.[4]
Climate change and a company’s contribution to it can also have a direct impact on the availability and pricing of property coverage. For example, several large European reinsurers have pulled coverage in the energy sector due to pressure from institutional investors.[5]
The responses of insurers vary by geography. European insurers typically want more details about a company’s ESG programs and performance. Meanwhile, generally North American insurers want a company to verify that it has established an ESG effort or that it has an environmental plan in place, although some insurers want to a review a company’s plan and base their renewal decision on it.
Climate Footprint and Risk Mitigation
Beyond ESG programs, companies are also reexamining their exposures to climate change and seeking ways to mitigate their risk levels across their operations.
Implementing Modeling
The scope, complexity and variability of climate risk have led many companies to adopt new modeling approaches. Traditionally, backward-looking catastrophe models have largely been focused on events such as earthquakes and windstorms. By contrast, climate models are forward looking and support the development of scenarios that can more accurately gauge the contributions of different factors to climate risk. Companies have made efforts to expand models to include secondary perils such as severe convective storm flooding or wildfires. This broader array of perils is the primary driver of a company’s risk transfer costs.
As companies develop plans to mitigate climate risk, they are selecting tools aligned with their business strategies and time horizons. Many climate risk models examine time horizons ranging from decades to centuries, generating a range of outcomes rather than exact forecasts.
Every company has its own unique risk profile compared with its subsector’s peers. Some tech companies have seen their global footprint grow by 20% per year, thus increasing their climate risk profile. In the past approximately five years, the risk management community has sought to more accurately assess its risk, which requires a huge amount of data and analysis.
Giving Risk Managers a Seat at the Table
To understand the impact of decisions on climate exposures and property coverage, many companies are including risk managers in the discussion. In ESG, common definitions have yet to be established, making reporting a bit more challenging. A number of organizations offer ESG ratings, but industries have not yet reached consensus on one standard. Companies can look to more mature competitors or sectors for points of reference.
From a mitigation standpoint, risk managers have an important role to play. For example, the real estate function might want to use more environmentally friendly laminated lumber in new construction, but insurers may choose not to offer property coverage for buildings with these materials. Such trade-offs should be examined early in the process.
Risk managers are also getting involved in decisions such as site selection, ensuring facilities are in locations with lower levels of overall climate risk. With their involvement, the process can incorporate scenarios that take the next 50 years into account as well as considerations such as where to put new locations and whether facilities affected by flooding or other natural catastrophes should be rebuilt in the same locations.
[1] “The Remarkable Rise of ESG,” Forbes
[2] “Beyond compliance: Consumers and employees want business to do more on ESG,” PwC
[3] “Capital Markets Modernization Taskforce: Final Report January 2021,” Ontario Ministry of Finance
[4] “Coal, oil sands companies feel growing insurance squeeze,” E&E News
[5] “ESG and the Future of Energy,” Insurance Journal