October 2024 saw the deaths of hundreds after catastrophic floods – reported to be most deadly deluge in a single country in Europe in more than 50 years – hit Eastern Spain, including Valencia. Survivors faced devastation to homes, livelihoods and infrastructure following slow and disorganized disaster planning and emergency responses by authorities, prompting protests by beleaguered communities.
Engineering experts have argued better use of natural catastrophe (natcat) and climate risk modeling before disaster struck would have helped mitigate the risks. We argue going beyond traditional stand-alone natcat and climate risk modeling is only one way of reframing climate risk management to better navigate what can feel like unchartered climate risk territory. In this article, we look at five ways you can go beyond traditional climate risk management boundaries to deal with the increasing volatility of acute (for example, flood and wind) and chronic (for example, heat and drought) climate risks and their amplifying impacts, specifically:
01
The historical data and short-term time horizon perspectives that inform traditional natcat and climate risk modeling aren’t fit for purpose on a standalone basis in an era where climate events are increasing in their intensity and/or frequency. Neither does traditional modeling go far enough when secondary perils are becoming as impactful as primary threats.
For example, a primary event like heavy rainfall can cause immediate structural damage, and then prompt landslides. These can prolong business interruptions and cause further damage to critical infrastructure.
Good practice physical climate risk management today means using modeling techniques alongside scenario stress testing to capture compounding impacts.
Imagine there was a massive downpour of rain after a prolonged drought in London (something we’ve already seen in September this year and in July 2021). To plan for this eventuality properly, you will need to understand how the dry condition of the soil will influence where excess water will flow.
You will also need to understand how local infrastructure would cope and the wider, immediate and longer-term impacts. There are a range of compounding effects where infrastructure fails: you can’t access your buildings; people move out or, in some areas, property market values may fall. These are the kinds of impacts traditional modeling doesn’t capture, which is why you need to stretch the boundaries of your physical climate risk assessment to include ‘what if’ scenario testing and more sophisticated and nuanced modeling techniques able to capture the actual vulnerabilities to your business.
Scenario testing – where you stress test your physical assets and value chain against a climate scenario – allows you to visualize and provide strategic insight into where potential issues could arise.
02
The traditional silos between treasury, risk management and sustainability no longer serve your organization in the face of escalating climate risks. By collaborating across departments, you can share insights and strategies, enabling you to identify and mitigate climate risks more effectively. Here, it’s important to understand and quantify the impact to your wider portfolio of risks and capture the return on investment when looking at potential risk financing and management strategies.
Sharing ownership of climate risk management also helps integrate climate risk management into wider business operations and helps ensure risk and financial decisions reflect long-term sustainability goals, enhancing your company’s resilience against climate-related disruptions.
An approach that goes beyond historical business boundaries will also help your organization respond to evolving climate reporting requirements. Regulations such as the EU’s Corporate Sustainability Reporting Directive (CSRD) require businesses to report not only how climate risk factors are impacting the balance sheet but also how the business is impacting the environment on issues like pollution and biodiversity (described as 'impact materiality' within the CSRD). This shift is likely to demand a far more integrated approach between sustainability, risk and finance functions.
For example, a risk manager looking to build resilience against a flood risk may have the option of recommending a flood wall or a nature-based solution originating from the sustainability function. A nature-based adaptation may be more expensive in the short-term, but could have longer-term benefits. Together, risk, treasury functions and sustainability can work to optimize climate risk spend and with it your ability to attract investors, employees, supply chain partners and insurance capacity.
03
We’re already seeing more organizations deal with climate uncertainty by refining their climate risk management and considering alternative risk transfer (ART) options, such as captives or parametric solutions focused on climate-amplified weather events. These can help your organization cope with the growing volatility of climate risks and the fragility of some insurance markets for certain risks.
Where insurance becomes harder to access or too expensive, a captive lets you build up surplus risk finance over time to help pay for the impacts of catastrophic risks such as floods or droughts. Parametric solutions can pay out when policy triggers are met, rather than there being specific property damage. For example, if climate change-amplified weather events damage infrastructure meaning you can’t get your goods to your customers, a parametric arrangement can give you a cash injection to help you cope.
By having the right data and a more nuanced approach to modeling risk as you consider ART mechanisms in tandem with traditional insurance, captives or sustainable physical risk adaptation investment, you can be more proactive when negotiating with insurers where you still require some conventional coverage.
By carrying out this extra work to understand what the actual risk looks like beyond traditional natural catastrophe and climate risk modeling, you differentiate your risk from your peers, making it more likely insurers will compete to offer you capacity.
04
Understanding how your supply chain partners and local authorities would respond in the face of a given climate threat manifesting, such as floods, can help you develop more robust business continuity plans and reduce the impact catastrophic climate events would have on your business.
For example, utilities and local authorities have publicly available plans in response to drought or flood. By widening your climate risk management view and opening lines of communication outside of your organization, you can better understand what key parties will be doing before, during and after an event. Such insight can sharpen your own business continuity and emergency response planning, making sure it builds on what others are doing to aid a better recovery and optimize your climate risk spend.
05
Generic statements, significant underestimates of risk and a lack of detail on plans to meet targets are common characteristics of many climate disclosures currently produced globally, research by the Financial Reporting Council finds. We agree many disclosure activities aren’t always supporting organizations’ ability to address and adapt to physical climate risks or develop management plans to navigate and accelerate the transition.
By taking a holistic approach that goes beyond historical disclosure obligations and considers environmental, economic and social systems, you can better understand the interplay of physical and transition risks. These insights will help you develop more resilient business models and identify new opportunities.
Going beyond climate disclosure metrics such as greenhouse gas emissions, will help shape a more resilient business strategy, capture future opportunities and manage risk. For example, if you can understand how and when physical risks and transition risks will affect your future profits, you can put your organization on the winning side of the transition to a low carbon economy and stay the course in a warming world.
To go beyond traditional climate risk management and find a smarter way to your climate-resilient future, get in touch with our climate risk specialists.
