Why Every Business Should Be Thinking About Climate Change Risks

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April 14, 2021


Overview

On top of the most severe pandemic the world has faced in more than a century, 2020 also endured an above-average number of natural catastrophes.

Along with their significant humanitarian impacts, these natural catastrophe incidents were additionally responsible for $268 billion in economic losses, Aon’s Weather, Climate & Catastrophe Insight: 2020 Annual Report found. The measured impact of climate change was especially meaningful this year. Of the total economic losses, weather-only disasters represented $258 billion — 26 percent higher than the 21st century average.

Given potential short- and long-term risks, many businesses are thinking more about climate change and its impacts. However, not all risks are as identifiable as the physical ones.

Stakeholders — including governments and regulatory authorities, shareholders and consumers — are increasingly scrutinizing organizations’ exposure and response to climate change risks and the steps they’re taking to address them. As they do so, climate change can expose those organizations to not just property and business interruption losses, but transition risks such as reputational issues, directors’ and officers’ exposures, and other liabilities.

“Organizations should think about climate change on two fronts,” says Corey Green, global operations leader at Aon’s Global Risk Consulting group. “One is managing the balance sheet impacts. The other is developing the organization’s stance on climate change and deciding how to report that to stakeholders. Though even with the same fundamentals, climate risk approaches will differ depending on company and industry dynamics.”

In Depth

Aon’s Weather, Climate & Catastrophe Insight: 2020 Annual Report noted that 2020’s catastrophes included a record-setting North Atlantic hurricane season, highly destructive severe convective storms, wildfires, floods and droughts. Key insights from the report included the following:

  • The year’s 416 notable natural disaster events globally included $53 billion in economic loss events, the third highest number on record.
  • The 1,922 fatalities during India’s monsoon season made it 2020’s deadliest disaster. Around the world, natural catastrophes were responsible for approximately 8,100 fatalities in 2020.
  • Among the year’s other notable disasters were the most widespread floods in China’s Yangtze River basin since 1998 with $35 billion in economic losses, and an August derecho windstorm with 140 mph gusts that devastated Cedar Rapids, Iowa, as it made its way across the U.S. Midwest.
  • There was also a record-setting Atlantic hurricane season and wildfires in the Western U.S. that set new records for acres burned.

“We continue to see rising sea levels that enhance coastal storm surge and what we call ‘sunny day’ or ‘nuisance’ flooding,” says Steve Bowen, managing director and head of catastrophe insight at Aon. “This year we also saw the hottest temperature ever recorded in the Arctic Circle: 100.4 degrees Fahrenheit. It’s the first time on record that temperatures there topped 100 degrees.”

Indeed, to climate scientists, 2020’s increased disaster losses are evidence of the impact of climate change — a challenge with increasing volatility.

For Businesses, a Climate Focus Becomes a Must

Companies are in various phases in their climate narrative, and all recognize the need to be engaged in the conversation around climate, says Patty Errico, head of global public affairs at Aon.

Investors and shareholders have increased their demands from companies to see more transparency and disclosures around risk factors such as climate. Asset manager BlackRock, with a stake in over 90 percent of the S&P 500, said in December 2020 that it would expect to see companies’ plans for decarbonization as a requirement for investment.

“Expectations go beyond investors as customers and employees seek to understand a company’s position on climate change to ensure it aligns with their values,” Errico says. “So climate policies can affect a company’s ability to hire and retain top talent and to capture and retain market share.”

With governments and regulatory bodies continuing to mandate more transparency around companies’ climate-related risk exposure, Errico says we can expect more standardized disclosure requirements on the horizon, as well as a set of globally accepted standards for reporting.

Errico points out that mitigation and adaptation projects continue to drive opportunities for companies, particularly with public-private partnerships. “As governments continue to balance alternative energy solutions, they’re looking to collaborate with collective resources that bring innovation, data analytics and creative solutions to the conversation,” Errico says.

“The reality is, numerous stakeholders are demanding increased transparency surrounding climate change intentions and actions from companies, both in terms of identifying risks and opportunities,” says Errico. “The key to building resiliency in climate change is having a framework for identifying long-tail risks and leveraging expertise and innovation to build actionable solutions.”

Looking at Sustainability Through a Business Lens

Numerous studies have shown the value of companies embracing environmental, social and governance (ESG) practices. As stakeholders place a greater emphasis on businesses’ exposure to and impact on climate change, it’s increasingly important that boards also focus on sustainability.

Bodies like the Task Force on Climate-related Financial Disclosures (TCFD) have provided frameworks to consider these risks and report on climate-related financial information.

“You can almost split the TCFD model down the middle in the way you approach it,” says Green.

“The top half of the framework is about identifying the risks and opportunities through an enterprise risk management lens; undertaking broad topic discussions about how the board or C-suite is thinking about the impacts of climate change on its business. Where does the business invest, what does it divest going forward?” he says.

“The bottom part is thinking about how we quantify those risks, transfer them if necessary and make sure we’re supporting the balance sheet.”

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Among the risks in that upper portion of the model are intangible risks associated with climate change, including policy, legal, technology, market and reputation — exposures the TCFD calls transition risks.

Climate change could also pose a directors’ and officers’ liability risk for businesses. All of which means that organizations that fail to identify or adapt to climate change risks could face shareholder litigation.

“There’s a need for climate change skills on the board or, at a minimum, ongoing climate change education for the boards of public companies,” says Laura Wanlass, partner and global head of corporate governance at Aon.

One area where this trend is becoming more urgent is in climate-related lawsuits against organizations. Most litigation thus far has focused on failing to disclose climate change exposures, but increasingly cases are pursuing claims against companies for not taking steps to reduce climate change risk. “These types of lawsuits can also help to drive shareholder activism and calls for say-on-climate or other environmental-related shareholder proposals,” Wanlass says.

Organizations also face potential reputational risks stemming from the nature of their business, who they’re doing business with and their potential impact on climate change. The potential damage from reputational crises can be significant and is growing in the social media era, a shift that is highlighting the importance of sound leadership to mitigate reputation risk.

“If companies do not proactively provide their own climate narrative, others will tell it for them. And depending on industry, silence may be just as problematic as not telling a story effectively,” Wanlass says.

Where to Begin

Climate change is increasingly top of mind for business leaders, even through the ongoing global pandemic — and perhaps because of it. “In the past six months, we’ve gotten more inquiries about climate change than ever before,” says Jeremy Barton, managing director, Aon Inpoint, Asia Pacific.

Green says companies that face regular physical risks due to climate change — like impacts of ever-stronger hurricanes or potential flooding on office locations— have a head start they can build upon.

But for many companies, addressing climate change is new territory. It can be overwhelming to know where and how to begin.

“Climate change means different things to different people. Start by getting collective thinking across the organization so you can build toward a single vision,” says Barton. “From there, you can start analyzing the risks and opportunities. And don’t be afraid to ask for help. Start small. But the important thing is to start.”