Climate change: the right tools in the box

Published on Thu, 11/03/2021 - 11:45

Risk management has a plethora of tools and techniques at its disposal, but are risk professionals well equipped to manage climate risk? By David Benyon, editor of Airmic News.

Combating climate change has stepped forward into the front rank of priorities for most organisations’ key stakeholder groups – from governments and regulators, to investors and shareholders, as well as business partners, customers and the general public.

Extreme weather, climate action failure and human-led environmental damage were the top risk numbers one, two and three, respectively, ranked by likelihood, in the World Economic Forum’s Global Risks Report 2021, published in January.

Climate change continues to be a catastrophic risk, the Global Risks Report noted, while “climate action failure” is the most impactful and second most likely long-term risk identified within the report. In the five to 10 year horizon, environmental risks such as biodiversity loss, natural resource crises and climate action failure dominate the risk landscape.

In January, incoming President Joe Biden re-entered the US into the Paris Climate Agreement, after the previous administration’s withdrawal from the international carbon emissions pact. In November this year, politicians from across the globe will meet in Glasgow for COP26, the UN Climate Change Conference UK 2021.

The pressure is on, therefore, for risk professionals to demonstrate they are actively engaged in managing climate risk, among other environmental, social and governance (ESG) risks.

“ESG risks are increasingly drivers of brand and reputation risk as well as legal and compliance risk,” says Julia Graham, deputy CEO and technical director of Airmic. “There is a revised UK Stewardship Code from the Financial Reporting Council, for example, in which ESG factors play a more prominent role.”

The new code took effect from 1 January 2020 to ensure ESG goes beyond aspirations or policy documents to show measurable actions with demonstrable results.

In a review of early reporting of the Code, the FRC said: “Climate change remains a critical area of focus for companies and investors, so it’s been particularly pleasing to see already some strong examples of effective engagement with the long-term strategic issues the climate crisis raises."

Embracing ESG, including climate change and biodiversity risks, will require an extension of the capabilities and competencies already used for other risks, from terrorism to flood risk.

“Risk intelligence and risk mapping assets and projects against an increasing array of risks and applying and adapting risk controls will enable risk managers to balance growth and the need to be responsible,” says John Ludlow, CEO of Airmic.

Data sets for risks such as flood have been correlated against geolocations to generate risk profiles for assets for some time and now a broader range of environmental risk factors need to be mapped.

For mainstream advisory and data providers, this means broadening their businesses with new expertise and acquisitions specific to climate risk to serve the risk community. For example, consultancy McKinsey & Company recently bought Vivid Economics, a strategic sustainability-focused consultancy and Planetrics, a climate analytics suite.

“Embedding climate risk factors into every sector has now become an imperative,” says McKinsey senior partner Cindy Levy. “The financial impact of climate change is significant, and stakeholders need the latest intelligence on physical and transition climate risks to re-allocate capital and transform portfolios.”

At the moment, each form of risk typically has its own tool or product. This silo approach does not seem like an optimal position, as there are logical limits to how many tools any risk professional wants to keep in the toolbox. Too few and risks might not be captured, while too many can become cumbersome or expensive.

“Risk mapping products that can be applied to more than one risk type would make the job easier, linking biodiversity with the other facets of ESG risks, as budgets and efficiency and budget constraints tend to limit how many tools are in a typical risk manager’s toolbox,” he says.

Catastrophe risk models are one useful tool, familiar to insurers and reinsurers as well as many risk management users, that can be adapted to provide climate risk intelligence, drawing on weather and climatic data from many of the same sources.

“Assuming clients are licencing cat models that already accurately reflect the current risk, then risk managers do have information to help them make sound short-term decisions,” says Peter Sousounis, director of climate change research, AIR Worldwide.

“Because climate change is happening slowly, cat models should be able to provide valid insight for a five to ten year period in most instances. On longer time horizons, where risk managers need information to make decisions for ten to thirty or more years into the future, cat models are neither as plentiful nor as robust,” he says.

Availability is still limited because creating such models is a challenging task, he notes, not least because scientists and modellers are looking far into the future to predict shifting and interrelated climate patterns, rather than a typical hurricane model using historical data to focus on a specific peril in the here and now.

“While future climate output is available from coarse resolution general circulation models, uncertainty exists from unknown emissions and socio-economic scenarios, model shortcomings, and absence of downscaled information. Additionally, risks may develop from phenomena that historically were not factors,” Sousounis says.

Solutions do exist however and will likely improve in availability, types of risks covered, and reduced uncertainty, he thinks. More broadly useful tools that will allow corporates, banks and insurance companies to holistically understand risk profile of sites and investments. This should enable risk managers to be more proactive.

“It’s core to Airmic’s theme for 2021 of “Driving Transformation – Shaping the Future” on risks as diverse as climate change and the pandemic,” Ludlow says. “As a profession we want to use business risk intelligence, understand the threats and vulnerabilities to the future environment, and shape risks and opportunities wherever possible to our benefit.”