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Climate Part 1: Direct Business Risks in a Changing World

By February 11, 2020 No Comments

Earlier this month, the World Economic Forum released The Global Risks Report 2020. This report is based on a survey of nearly 1,000 policy makers across academia and the public and private sectors. I always make a point to read through their yearly report in detail, not only because it’s directly useful for my work, but because it’s interesting to see how the perceptions of risk change over time.

This report has divided the dangers facing humanity into thirty items, sorted into five categories. It has then ranked these in two different ways, both by their likelihood and by their impact. This year’s report has already generated a great deal of attention, given that the five environmental items together account for the five most likely risks; meanwhile, three of the five have been judged to pose the greatest risk in terms of impact, with climate action failure beating out weapons of mass destruction.

Over the last few years, these reports have increasingly listed environmental risks among the top five of both categories. This is not surprising, what with increasing public concern about climate change and the number of high-profile climate events over the last few years. However, both the dangers and the public consciousness surrounding them raise some interesting and unanticipated risk-management and insurance management concerns that directly impact every business that we work with.

Of course, the most obvious of these concerns are those resulting from direct weather events – indeed, I’ve already discussed the issue of hurricane-generated pollution risk and how exposure to this risk is much more widespread than most business owners might initially realize. However, major weather events are not the only thing that business owners should be looking out for.

For example, several months ago, we were engaged by one of our existing clients to consult on the construction of a new property they were building in a coastal community on the East Coast. In our opinion, the initial plan for the building did not incorporate sufficient protections against flooding. The original design made some sense given the current context of that area, and complied with current zoning and construction requirements, but the context will likely change ten or twenty years from now; as sea levels rise and weather patterns shift, many coastal communities on the East Coast will become subject to more regular and severe flooding during high tide. This threat is even more pronounced during weather events like hurricanes, though it is not limited to them.

More specifically, I was concerned that not “overengineering” the building against flood would increase my client’s future flood insurance premiums. As such, we suggested that our client rethink the design of the building, and that they be prepared for a hypothetical flood that would put eight feet of water in their building for a 12-hour period.

Ultimately, this became a capital budgeting decision: the client balanced the additional costs to better secure the building against our best guess about future flood insurance premiums. The new design now calls for a higher building base. Furthermore, mechanical components were moved to a higher floor, while first-floor tenants will now be provided with a “flood preparedness plan”. In the end, my client will have a better, safer, and more secure building, which will, ultimately, be a more valuable and profitable long-term investment.

Insurance can effectively complement other risk management approaches to minimize losses and keep your business from being significantly damaged. However, as I discussed in the blog post about hardening insurance markets, it is becoming increasingly difficult to get coverage, let alone affordable coverage, especially in catastrophe-prone areas. Since writing that blog post, the situation in certain areas, especially disaster-prone markets like Houston, has only gotten more difficult to manage, and even if the hard insurance market that we are in ends over the next few years, it is looking more and more possible that insurance for certain areas and specific kinds of risks will “harden” permanently. In that regard as well, anticipating risks and taking certain precautions early on in a project might make dealing with insurance easier down the road.

While the direct effects of global warming are the most apparent, the more indirect ones might warrant even more attention. We’ll discuss some of these in our next post.

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