Prior to the emergence of the COVID-19 pandemic, climate change was considered the top risk in public consciousness. While the coronavirus has overtaken it in the short term, climate change remains a larger challenge in the long-term, with lasting effects on the physical environment and the economy.
According to Jessica Turner, PhD (pictured), senior vice president of catastrophe advisory at Guy Carpenter, there is a general consensus that the future economy must be a low-carbon one. However, there is considerable uncertainty around the pace of this transition.
“Business and risk managers therefore face challenges both from physical risk, the risk that properties are damaged by the increased frequency and severity of natural disasters, and transition risk, the risk to investments and other economic activity from economic rebalancing,” she told Corporate Risk and Insurance.
Turner said that companies must assess the physical risks their businesses are exposed to, which vary from region to region.
“For example, heat waves, flash flooding from extreme precipitation, and wildfires are more directly linked to climate change and their response is more predictable,” she said. “Other perils and regions such as North Atlantic windstorms over Europe are less materially impacted. The time horizon matters too – over the next five years sea-level rise may not be significant, but it could be the dominant risk at the end of the century.”
Transition risks should also be assessed, depending on industry. Turner identified several industries that could be affected by the transition to a low-carbon economy, including fossil fuels, aviation, agriculture, and “fast fashion”.
Physical and transition risks aren’t the only pressures faced by businesses due to climate change.
“Regulators are increasingly asking for evidence of a climate change strategy and a quantification of the risk, often using scenario analysis,” Turner said. “A leader in this space has been the UK’s PRA, but other countries are following suit.
“Additionally, more companies are disclosing their climate change risk to investors and shareholders yearly. Since the creation of a disclosure framework by the Taskforce on Climate Change-related Financial Disclosure (TCFD) in 2016, this has been an increasingly popular method of disclosure, with over 1,400 supporters. Rating agencies are also including Environmental, Social and Governance (ESG) criteria in their ratings.”
Public opinion has also been exerting increased pressure on business operations.
“Customers and employees want companies to be socially responsible, including around climate change,” Turner said. “Activists are keeping the issue in the public eye through raising awareness and even bringing litigation for either a companies’ role in adding to emissions or failing to disclose climate change risk.”
Returning to physical risk, which is likely the largest climate change-related pressure to a business, Turner advised businesses to do their homework.
“The first step to incorporate climate change physical risk into decisions is to assess the risk and understand its potential materially,” she said. “At a minimum, this means understanding, in a qualitative way, the key scientific literature such as the latest Intergovernmental Panel on Climate Change (IPCC). To go further is to quantify the risk numerically. There are a number of tools and processes available, ranging from expert judgment to risk scores, to climate conditioned cat models.
“In truth, however, the number of products currently commercially available in the market is small. Guy Carpenter is working to address this critical market gap by performing research on perils and climate change, advising on the use of cat models in a changing climate and helping our clients understand the complexity associated with climate change.”