The Climate May Be Beyond Your Control, But The Risk Is Not

Although a pandemic, civil rights movement and impending elections are what dominate the news, the Earth’s climate quietly continues its steady transformation, presenting organizations with serious new property risks and potential long-term financial loss.

Many business leaders, unfortunately, say their companies are less than fully prepared for climate risk. As a result, organizations, shareholders and careers may be in jeopardy.

With Atlantic hurricane season upon us through November, there’s no better time to address climate risk — the threat of adverse financial impact related to a changing climate. This financial impact could stem from property damage and business disruption caused by cyclones, flooding, wildfires and more.

Many organizations aren’t quite ready. More than three-in-four (77%) CEOs and CFOs of the largest companies in the world recently acknowledged that their firms are not fully prepared for the adverse financial impact of a changing climate. Perhaps because the climate seems so monolithic, more than eight-in-10 (82%) believe their companies have somewhat to no control over such an impact on their business.

This is where I’d respectfully differ. Business leaders do have significant control over climate risk. Not the climate itself, of course, but the financial impact of climate-related property damage.

What is climate risk?

Climate risk, despite its inherent mysteries, is essentially conventional property risk in a different package. We’ve all seen hurricanes, floods, droughts and wildfires before. It’s just that the nature and degree of some of these hazards are evolving. Sea levels are rising in parts of the world; wet areas will likely become wetter, increasing the risk of flooding; dry areas will likely become drier, increasing the risk of wildland fire.

Flooding is a particularly grievous risk. It cost the world more than US$1 trillion from 1980 to 2019. Hurricanes are expensive, too, with US$67 billion of Hurricane Harvey’s estimated US$90 billion price tag attributed to human influence on the climate.

The prospect of climate-related disruption – financial and otherwise – is a heightened global concern. For the first time in the World Economic Forum’s 10-year outlook, the top five global risks in terms of likelihood are all environmental.

Business leaders need to understand that the total financial impact of major business disruptions can last for years. A hurricane that strikes today can destroy company value for the long term. Although the immediate business disruption and short-term hit to revenue may be covered by property insurance, market share, growth opportunities and investor confidence may never be recouped. The cost of these lost opportunities will often be greater than sound investments in resilience.

Shareholder value will drop

New research supports it. Independent analytics advisory firm Pentland Analytics looked at all 71 publicly traded companies which had reported financial damage in their 10-K statements from a major flood event in recent years. Twelve months after the event, their shareholder value had declined by an average of 5%, equivalent to a collective US$82 billion. That kind of loss you may never truly erase, no matter how well you rebound. You’ve lowered your baseline for future growth compared with companies that were resilient.

Flood losses used to be shrugged off as bad luck, and shareholders would give you a break. But the research shows that shareholders now view flood damage as bad management. We saw similar results in some hurricane research we commissioned last year. The shareholder value of companies that had implemented all of our storm-protection recommendations prior to Hurricanes Harvey, Irma and Maria outperformed by 10% in shareholder value those who hadn’t finished doing so.

As a CEO, you’re not going to involve yourself in the minutiae of loss prevention, but it is definitely worth taking time to ensure that your organization has a climate-loss-prevention strategy. It should involve thoroughly assessing the risk, quantifying it, then mitigating it. It’s a matter of governance. Failure to protect company value, when the tools are available to do so, is a failure in governance. Increasingly, shareholders think so too.

Assess, quantify and mitigate the risk

The following can serve as marching orders to your chief risk officer, CFO or risk manager:

1. To assess your climate risk, your staff should conduct engineering reviews of all your properties to understand how vulnerable they are to climate-related financial harm. When developing a flood scenario, for example, your staff should determine how much water to expect, that water’s likely velocity, and the contaminants it will carry into your premises. Flood risk maps are a good place to start, but your team shouldn’t fall into the trap of assuming that if you’re in a “100-year-flood zone” (meaning there’s a 1% chance of a flood every year), you won’t get deluged on your watch.

2. Direct your staff to game out a range of property-loss and business-disruption scenarios at all your properties and throughout your supply chain. Quantify the value of each potential loss in relation to your overall profit. Understand that small, specialty components you might source from a partner or modest, unassuming buildings can have an outsized impact on your business performance.

3. Now that your team better knows the likelihood, severity and cost of climate risk to your business, mitigate it. Prioritize loss-prevention measures, which in a flood scenario can be as major as relocating facilities and as minor as elevating machinery, building curbs in the parking lot to reroute drainage, or purchasing inflatable dams to block floodwaters from your property. Remember to build for risk that will be present 50 or 100 years down the line. Many facets of climate risk will be higher then.

4. Finally, ensure you have an emergency response team backed by sufficiently detailed emergency response plans and defined triggers to activate them. Do the same for other natural hazards.

Even during a pandemic?

But wait, you may say, “We are 100% focused on COVID-19.” That’s understandable, and I can certainly sympathize. But the meteorologists and climatologists have warned us: When a flood, a hurricane or a wildfire hits, it is guaranteed to be chaotic at least.

You won’t have time to plan or to prepare when it hits. You will wish you’d prepared when there was time, when there was a bit of energy to spare. That time is probably now. And climate risk management is a great project to delegate to risk managers, facilities managers and their associates.

When the disaster arrives, there will be winners and losers. Shareholders will punish organizations for outcomes that once looked like excusable bad luck. Good outcomes will be seen as the result of strong leadership. And it will be rewarded.