Addressing climate risk through modelling and resilience

Climate risk is a huge topic, providing numerous challenges to corporates and their risk managers. The sheer scale and breadth of the risks, covering so many different operational areas, can make it seem like an impossible task. But getting the right data, using cat modelling, and breaking the risk down into categories to manage are all part of dealing with climate change risks.

Climate change is tied to tangible risks where the impact can be immediate and measurable, says Thomas Riddell-Jones, climate change consultant, Aon. This includes, but is not limited to, business interruption, material scarcity, supply chain issues, and reputation damage.

“Climate risk, either derived from climate change or climate-related events, is therefore often addressed when there are financial repercussions associated with it. Financial risk ends up being the lens through which most corporates assess their climate risk. Once that is established, risk can be broken down into categories, such as physical, transition, liability, and regulatory, which address various risk touchpoints. This segmentation helps risk managers create bespoke approaches and therefore improve the overall risk management by assessing risk holistically,” he says.

When it comes to developing climate resilience, Riddell-Jones says that while considering specific risks like physical, litigation, and supply chain risks in isolation can provide a detailed understanding of the threats posed by climate change, it’s essential to adopt a holistic approach. “This is key in order to fully grasp the interconnected nature of these risks and develop effective resilience strategies – which, in order to be delivered successfully, requires a top-down approach starting at the board level. It’s also important to consider that different geographic regions will have different risk-based needs, therefore negating the notion that building resilience is, by any means, formulaic,” he says.

Risk management associations like Amrae have started to address climate risk, and to help members to organise their actions. Michel Josset, director of insurance and loss control, FORVIA Faurecia, and a member of the Amrae board of directors, said Amrae has six working groups about climate risk, corresponding to the different challenges facing risk managers about climate:

• Know (how to develop knowledge about climate change and access exposure data);
• Organise (how to collaborate with other functions such as ESG, sustainability, insurance, etc);
• Adapt (how to mitigate climate physical risks and address transition risks);
• Insure (how to ensure coverage for most exposed assets and obtain coverage for new low-carbon products or activities);
• Report (how to comply with new non-financial reporting obligations such as CSRD, etc);
• Regenerate (how to understand the impact of biodiversity collapse and kick off biodiversity regeneration actions).

“Climate change impacts corporates’ risk universe, creating new risks and opportunities,” says Josset. “All corporates should adapt their risk mapping to address the new risks related to climate (both acute and chronic physical risks exposing activities, assets and supply chain), transition risks, and legal and reputational risks.”

He says the maturity of corporate governance about climate change is growing rapidly. “This risk is now on top of the agenda of management and is an important criteria for any strategical decision. Risk managers will drive this change in full cooperation with other functions involved such as ESG, sustainability, insurance, HSE, HR, purchasing, and so on.”

Riddell-Jones says risk managers are already tuned into the existential threat that is climate change and the increased frequency of natural catastrophes, especially with regards to how those can affect business continuity. “As a result, the role of the risk manager has certainly evolved as industry at large has come to perceive risk as multidimensional, requiring strategies for a roster of impending risk, including cybersecurity, human capital, and more.

As more corporates begin to assess the multidimensionality of risk, we’re likely to see them build risk management teams dedicated to assessing climate risk,” he says.

Climate modelling

It is not easy for risk managers to get the right data on climate risk for their organisations, and even harder when it comes to supply chains. Catastrophe modelling is available to corporates, and creating bespoke models is possible, dependent on the type of risk that companies are exposed to.

Josset notes that (re)insurers have significantly lowered their capacities for areas most exposed to climate change through sub limits included in property and business interruption contracts. “Corporates should therefore systematically assess their loss expectancies in most exposed areas where they have multiple assets, using the same cat modelling services currently reserved to insurers and reinsurers.”

Riddell-Jones explains that most climate models are based on IPCC data, which is now in its sixth iteration and models scenarios globally based on hundreds of different data sources. “That said, some things simply cannot be modelled or accounted for, such as local geology due to matters of scale. For these circumstances, managers often have to refer to special climate model providers, which they can use to inform clients. An existing challenge for some is modelling climate in the global south, which hasn’t benefited from prolonged historical data measurement such as in the US and Europe,” he says.

“The access to exposure data taking into account IPCC scenarios for their footprint is key to kick off adaptation road maps,” says Josset. “A market for these data is emerging but still lacks maturity. When corporates manage this data properly for their footprint, they will extend the risk analysis to their critical suppliers.”

But Riddell-Jones believes that modelling shouldn’t be treated as the last port of call for mitigating risk. “Expanding our knowledge through scientific research and access to climate experts, for example, helps determine whether the physical hazard itself is getting worse or not, the implications on different types of perils, and how this varies across regions. This is where academic research and innovation can unite to bring emerging climate research directly into the insurance industry and create actionable insights,” he says.

Josset has some messages for the insurance market on climate change. He says most insurers are quite late in extending their traditional fire prevention loss engineering service to climate risk expertise, and they should boost their technical assistance and make their data available to their customers.

In addition, he says the threat of lack of coverage for most exposed assets is rising in the short/medium term, and insurers should be more transparent with their customers regarding these assets as adaptation and possible relocation need time.

Josset acknowledges that incentives exist for fire prevention on properly protected assets, but says insurers should extend these incentive schemes for customers developing adaptation actions around climate change.

And finally, he notes that corporates of all sectors are investing massively in the decarbonation of their products and activities (through hydrogen, low-carbon construction materials, renewable energies, etc). “The risk appetite of insurers for these innovations is low as insurers consider that they lack loss records and perspective. Corporates and insurers should foster technical dialogue around risk analysis and prevention, as the ecological transition will not happen if not sustained by the insurance industry,” he warns.