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Why and how to create a climate risk strategy for competitive advantage

Outsmarting uncertainty webinar series

By John Merkovsky , Torolf Hamm and Lisa Lipuma | February 27, 2023

Climate risk impacts value and supply chains, so needs to be managed and financed. How can you position your organization to thrive in different climate scenarios?
Captive and insurance management solutions|Corporate Risk Tools and Technology
Climate Risk and Resilience|ESG In Sight
Climate risk for your business: The missing role of the risk professional

Find out how risk managers can lead the pack by demonstrating how climate is a matter of quantifiable risk and an arena for opportunity.

A robust climate risk management and financing strategy can attract more investment to your organization and position the business for long-term resilience. But in attempting to manage and finance climate risk management, you could face organizational hurdles. These obstacles might include a sense of climate action being a nice-to-have, or effective climate risk management feeling too overwhelming or too complicated for leaders to feel ready to act.

This insight, based on a WTW webinar looks at how you can outsmart these uncertainties and ensure the business is ready to benefit from the opportunities.

Understanding climate as a risk issue

Climate disclosure regulations, such as Task Force on Climate-related Financial Disclosure (TCFD)1 requirements don’t originate from environmental agencies; they’re issued by financial regulators and international standards institutions. That’s because climate is a risk issue.

It’s critical your business is enabled to talk about climate routinely, identifying the climate risks to your assets, your people and the human rights in the areas you operate. This isn’t about ‘doing good’ or learning a whole new language around ‘climate’. Organizations already have the vocabulary they need to discuss climate, and that is the language of risk management.

Jumping mental barriers on physical risk management

You can think of climate risks as like every other risk, only a longer forward-looking timeline.

We’re facing huge physical risks in the future, and a period of major upheaval to try to prevent those risks. These so-called ‘physical risks,’ are the result of a warming world: wind, flood, heat stress, drought, sea-level rise, wildfires, and the like.

Physical risks should feel familiar to you and your board; they’re much like natural catastrophe, property damage and business interruption risks but over that longer time horizon.

Physical risk phenomena follow the rules of physics and atmospheric science. This means you can model, for example, what would happen if the world heats by 2.6 degrees, how this will impact your organization’s assets and supply chains and assess the financial impact. You can also model the impact of different resilience actions.

We recently worked with a manufacturer that used a diagnostic model to determine how far assets that relied on hydro-electricity would be impacted by energy shortages in the wake of drought stress. Modelling provided insight on the number of drought months it could expect on an annual average for future decades and climate scenarios, delivering the manufacturer it needed to create resiliencies.

Identifying the opportunities around transition risk

Transition risks are those risks associated with a move to a low carbon economy. These are business-related risks arising from societal and economic shifts and include policy, regulatory, technological, market, reputational and legal risks. However, transition risks also represent strategic opportunities for your organization.

While transition risks can’t be modelled in the same way as physical risks, they are still scenario-driven. For example, one of the most obvious areas of transition is related to energy. The International Energy Agency has released insights on the path to net zero and how change might manifest,2 including technological changes, commodity price shifts plus price volatility or dislocations in talent availability versus demand.

Understanding the transitional risks and opportunities can help to ready your business model to, for example, hedge around commodity prices, or develop strategies now to win the talent you’ll need tomorrow. This converts the risks around the next industrial revolution into competitive advantage.

You already know how to manage climate risks

Transitional risks such as those around technology and talent aren’t new, but they are being amplified by climate. So, how do you manage these heightened risks?

Good climate risk management is the same as other risk management: it’s built on good governance and the methods and processes of enterprise risk management. These apparatus include a strong risk committee with a cross-functional group of people who have the reach and influence within your company to tackle climate as a risk issue and finance a robust, insight-driven climate risk management strategy.

Thinking about the manufacturer we mentioned earlier, this organization used the analytics for climate disclosure and then went further. It used disclosure assessments to understand climate risk vulnerabilities for its operations and supply chain. It then assessed the risk financing strategy, following the climate risk diagnostic of the whole value chain, and ultimately baking the resulting climate risk management strategy into a sustainability strategy.

Next steps for your climate risk management

There are a range of immediate actions you can take to tackle climate risk to support success over the long term. Some of the following could inform your climate risk management journey:

  • If you haven’t already, investigate your disclosure requirements, as well as investor expectations, customer and employee demands around examining your climate risk.
  • Don’t neglect essential enterprise risk management: doing the work so your business strategy, climate risk strategy, and risk finance strategy are aligned and coherent is vital.
  • Use analytics to quantify your risks under at least two climate scenarios, then can carry out cost-benefit analysis around the adaptations and mitigation actions.
  • Climate change means higher volatility and changes to the risk profile of the companies you depend on in your supply chain. You need to build and finance resiliencies and/or work out the optimal means of mitigating or transferring the risks. For example, parametric solutions can help with non-damage business interruption for external suppliers to manage climatic impacts such as floods or droughts.
  • Consider captives. These structures can also play a role in encouraging funding for the risk adaptations to reduce the impact of physical climate risks and/or investment into technologies to mitigate climate change.

Outsmarting Uncertainty webinars cover a range of subjects designed to benefit risk and insurance professionals. Our aim is to provide you with the knowledge and confidence to make more informed choices on behalf of your organization.

Footnotes

1 Task Force on Climate-related Financial Disclosures

2 Net Zero by 2050, International Energy Agency

Authors

Head of Risk & Analytics and Global Large Account Strategy, WTW

Senior Director
Physical Risks, Climate Practice
Risk & Analytics

Director, Risk and Analytics

Lisa leads WTW’s Enterprise and Transition Risk Consulting practice for North America and has 15 years of experience in risk and insurance. Over the course of her career, she has led large strategic consulting engagements and pioneered the development of WTW web apps including Global Peril Diagnostic, a natural catastrophe and terrorism model, and Collateral Quantified, an actuarial reserving and negotiation tool. Lisa helps organizations navigate, quantify, and make efficient investments to control their strategic and enterprise risks. She is part of WTW’s Global Climate Strategy Task Force and takes a leading role shaping WTW’s Risk & Broking large account strategy.


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