Scenario planning for climate risks
People are becoming more aware of the increasing frequency and intensity of climate events, and corporations are slowly responding to this increased awareness among customers. However, it may not have reached the point where such risks start to significantly influence how organisations do business.
Hence, the question is: when will action on climate change reach a tipping point, ie when will climate change become a c-suite issue and when will organisations start to take concrete actions? Some believe the stressor that will bring organisations to this tipping point is regulatory (for example, the Task Force on Climate-related Financial Disclosures, which is currently voluntary, becoming compulsory, or the levy of carbon taxes), while for others, it will be changing consumer attitudes. In addition, the increasing risk of insurers and financial institutions of bearing the responsibility of the environmentally harmful activities of their customers is starting to drive a change in investment strategy.
The main challenge in developing long- (or even medium-) term risk management strategies is the high level of uncertainty and complexity inherent in the climate change phenomenon. Current tools, such as design force levels for new construction and catastrophe models used to price natural hazard risks, have not been adapted to account for climate change. There is a pressing need to develop tools that assess the evolution of climate change effects, but it is going to take time for such tools to be developed. In the meantime, implementing a scenario-based approach using existing tools is the recommended approach to develop climate change strategies.
Considering the global interconnectivity of climate risks and their wide-ranging impact – social, political, economic, public health, to name but a few – a multi-stakeholder collaboration is necessary to develop effective solutions.
Climate change risks
Climate change impacts almost every aspect of life, but the risks are generally classified into physical, transitional and liability. Examples of the physical risks are the impact on people, buildings and infrastructure, while transitional risks include changing consumer trends, for example due to increasing temperatures. Liability risks impact insurers and financial institutions, which may be deemed responsible for the environmental impact of their customers’ operations.
With proper planning, such risks may also provide opportunities.
Adaptation to climate change risks requires a very high level of investment and the right tools.
From a physical risk perspective, simply relying on historical data – as is the case with, for example, building design codes, urban planning regulations, etc – are highly unreliable for climate change planning purposes.
Scenario planning
Rather than wait for the tools to reach a level of accuracy where organisations can start planning with the same level of confidence that is currently possible with tools that rely on historical data, we recommend taking a scenario-based approach. This will allow organisations to develop potential risk adaptation and mitigation measures, and may also identify opportunities as well as threats.
Scenario planning looks at how the various components of risk will evolve and respond to climate change. This type of planning can be done at site level or at whole-value-chain level, looking at the entire operation globally, including supply chain, infrastructure, utilities, etc. Scenario planning can also be used to determine changing consumer trends, technological developments, changes in regulations and more.
A broad roadmap of the adaptation strategy using scenario planning involves the following steps:
- Identify the broad business and strategic risks, which involves understanding the business exposures, vulnerabilities (organisational, financial, physical, etc), and the hazards potentially impacting the business;
- Develop a granular view of the risks involved – including, for example, individual locations;
- Develop a mitigation strategy involving insurance and resilience.
The involvement of as many stakeholders as possible will increase the usefulness of such an exercise. Each stakeholder will have a different perspective on how their part of the organisation will be impacted. The commitment of the c-suite to the strategies developed from the scenario planning will ensure the necessary resources for effective implementation. The c-suite is generally interested in the global view – where are the hotspots that need to be focused on and what could potentially happen? One of the strongest benefits of the scenario-based approach is that it can make climate change effects tangible to people. By starting off global and then refining the geographic granularity – from regional to country to local level –you can engage with different people in the organisation and experts.
Insurers have deep insights on climate change trends, as we are constantly monitoring the impacts on ourselves and our clients, so we have a very broad perspective that is not focused solely on physical, but also on transitional risks. One of the benefits of working with insurers is that while specialists will look at very specific parts of an organisation, insurers have an overview of the specific risks facing each industry, for example related to supply chains, raw materials, utilities and infrastructure. Organisations can then take that information and analyse it to a deeper level and in greater detail, involving the necessary experts.
Contributed by Amar Rahman, principal risk engineer/global practice leader natural hazards resilience, Zurich Insurance Group
