The rising importance of ESG is clear, but how does this affect risk professionals?
Environmental, social and governance (ESG) factors, including climate, are not only the preserve of sustainability and investor relations teams. Climate in particular is a sphere where risk professionals can and should take a central role in supporting their organizations’ resilience.
This insight, based on perspectives from WTW’s Outsmarting Uncertainty webinar series, suggests five key climate questions for businesses. These issues can help define the critical role of risk management in helping businesses adapt to a warming world and the transition to a low-carbon economy.
Climate is not a single risk. It’s a range of risks that can be grouped under the broader headings of ‘physical risks’ and ‘transition risks.’ Physical climate risks are those arising from climatic events and are broken down into either acute or chronic risks. Acute physical risks include droughts, floods and wildfires, while chronic risks include rising temperatures, but also factors such as the expansion of tropical pests and diseases into more temperate zones, as well as loss of biodiversity.
Transition risks are those related to the move towards a greener economy. Transition risks cover issues such as shifts in policy, regulation and consumer preferences. They also include legal risks, such as climate litigation by shareholder activists that could impact the costs of doing business and/or the viability of your business.
The diversity of risks involved in addressing ‘climate’ demands organizations are well-equipped with adaptable risk management and risk governance apparatus to identify and interrogate the full range of physical and transition risks.
To support long-term resilience, your organization needs to drill down into how changing acute events and chronic climatic changes could affect the valuations of assets. What does climatic change mean for your production, manufacturing or customer service sites or data centres, and their ability to operate in the eventually of acute and chronic climate changes?
By modelling future changes in climate hazards under various climate scenarios and time periods, you can understand the impact on valuations. It can also drive decisions around whether you should be disposing of assets in areas likely to be impacted by wildfires in coming decades.
This kind of climate scenario analysis can also tell you if a call centre is based in a location where heat stress is likely to impact workers. This would mean the business needs to develop mitigating measures now, such as building modifications or changes in shift patterns.
Transition risks cover the following sub-categories:
The business needs to get a handle on transition risks to avoid outcomes such as write-downs and stranded assets. Transition risks can also lead to the business selling off of assets for lower values and in a disorderly way when policy or technology moves against your current operations or business model in the shift towards a low-carbon economy.
Climate is inherently interconnected with other critical operational, financial, and strategic risks and is also capable of widening and deepening their impact.
Let’s think about water scarcity to illustrate the interconnections.
The United Nations says inadequate water supply is an increasing problem on every continent and the impacts of a changing climate are making water more unpredictable.
Let’s say you’re a food producer with crops in areas suffering drought and extreme heat. In the absence of rain, your crops require extra irrigation, putting pressure on water supplies. The less water there is, the lower its potential quality which could lead to reduced yields. This could mean higher prices for end customers and a deterioration in consumer sentiment and sales.
In this scenario, a climate risk becomes an operational issue that opens social and reputational risk that could amplify the initial damage to the bottom line caused by the original climate risk of water scarcity.
It’s also worth saying here how a physical climate risks like rising temperatures don’t remain neatly within the ‘e’ (environmental) pillar of ESG. Worker safety, for example, is an issue in heat-stressed environments (a ‘social' issue). Thinking about our hypothetical food producer, its leadership could be called out by shareholder activists if it fails to put controls in place to protect field workers from heat exhaustion and heatstroke (a ‘governance’ issue).
It’s perhaps easy to feel overwhelmed by the prospect of identifying and managing the panorama of climate-related risks. But as much as you can start climate conversations with questions liable to reveal gaps in knowledge and vulnerabilities in business models, you can also reveal the potential openings in a warming world transitioning to a low-carbon economy.
For example, does the location of a manufacturing site likely to be impacted by floods enable you to negotiate better terms on the site’s lease? Also, if you’re able to use actuarial forecasting to predict likely disruption to a particular supplier, there could be first-mover advantage in exploring alternative suppliers. And when you are competing for the brightest and the best of the next generation, having a robust story on climate could help you win tomorrow’s talent, supporting the long-term success of the business.
For support on advancing your climate risk management, get in touch.
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.
WTW offers insurance-related services through its appropriately licensed and authorised companies in each country in WTW operates. For further authorisation and regulatory details about our WTW legal entities, operating in your country, please refer to our WTW website. It is a regulatory requirement for us to consider our local licensing requirements.
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.