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The Cost of Climate Change Risk On Your Balance Sheet Is Bigger Than You Think

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The Cost of Climate Change Risk On Your Balance Sheet Is Bigger Than You Think

Increasing floods, severe storms, record high and low temperatures; climate change is already having an impact. This is just the starting point, warned Willis Towers Watson’s Head of Natural Catastrophe and Climate Risk Management Torolf Hamm. Even in the best-case scenario, a one-and-a-half degree rise in temperature, severe weather events are likely to become the norm.

If a business isn’t already quantifying the cost of climate change risk, its bottom line will feel the effects soon. The physical risks lie on one side of the coin: flood damage, the cost of cooling buildings, loss of land to coastal erosion, supply chain interruption. On the other side of the coin are transition risks: the impact of policy changes, increased insurance premiums and changing consumer behaviour. All these risks will arrive at some point.

“It’s concerning that businesses are coming to us knowing so little about climate change,” Hamm said. “But there is hope. As climate change is talked about, more clients are becoming more aware of the risks. Over the last five years, climate change has reached the board level agenda as top executives witness climate volatility.”

Increasingly, Willis Towers Watson is being approached by corporates and financial institutions asking: “What does climate change mean for my organisation?” Businesses feel the pressure from young people, investors and shareholders to do the right thing. 

How To Quantify Climate Change Risk

“Businesses tend to approach us with a shopping list of questions on all aspects of climate change,” Hamm said. “The first thing we do is help them to understand which questions are important. Preparing for climate change means different things for each business.”

There is a series of overarching questions that each company should ask, however. Have you got a climate change risk register, including timelines? Have you identified the most material risks? Have you looked at scenarios that quantify these risks and found ways to mitigate them through informed, strategic decisions?

One such business is Landsec, which asked Willis Towers Watson to help. Landsec’s wide portfolio, with properties ranging from commercial to residential, could be exposed to many risks.

“Landsec has always looked at risk in a sophisticated way,” Hamm said. “They were quantifying catastrophe risk years ago. When they asked us to help them understand climate change impact, we took their list of questions, clarified some as immaterial and came up with the top five questions they should be asking. That gave them a very different view to what climate change could mean for the company.”

To create a climate change strategy, risks must be quantified financially. In short, a business needs to weigh up the cost of doing nothing about each risk, of spending money mitigating the risk and of risk transfer — insuring against the risk.

“Risk transfer is all about taking control,” Hamm said. “A business can transfer risk to an insurer, but premiums will rise. The question is, how much risk can you retain on your balance sheet yourself and how much do you need to spend to reduce this through proactive measures? Strengthening roofs, adding water pumps, insulating — we help clients identify measurable ways to reduce the cost of risk.”

Of course, when risk sits on the balance sheet, it also sits in people’s minds. Increasingly, institutions are being pressured by policymakers only to invest in businesses that pay attention to sustainability, for example. People might start to shun a business that is doing nothing. What will this cost a business?

The Cost of Climate Change Risk On Your Balance Sheet Is Bigger Than You Think

With Risks Come Opportunities

Doing “the right thing,” produces opportunities while reducing risks, such as lower running costs, Hamm said.

“Unsurprisingly, businesses have a financial motivation to reduce their risk profile and formulate a strategy to do it now,” he said. “This is how to capture the attention of the CFO.”

To identify opportunities, a key strategy is to look at other societies. In the UK, for example, the real estate sector has until now focused primarily on preparing for winters. We should also be looking at summers.

“We need to look at societies where buildings are already designed for warmer climates and compare these with our own assets,” Hamm said. “If the buildings can’t be cooled effectively, perhaps a property company needs to think about divesting those. If you’re at risk of floods, do you want to keep business critical items in the basement? In other countries, basements are tiled.”

Willis Towers Watson also relies heavily on research to create its forecasts and climate change models. The firm leads a network of 60 or so academic organisations that carry out climate change research. Using these studies, Hamm’s team calibrates current catastrophes using climate change models of the future to see what the impact could be.

Willis Towers Watson is also a key advocate of the global uptake of the Task Force on Climate-related Financial Disclosures (TCFD) framework. This is a market-driven initiative, established to develop a set of recommendations for voluntary and consistent climate-related financial risk disclosures in mainstream accounts filings. The aim is to guide companies when providing information to investors, lenders, insurers and other stakeholders. It is fast becoming mainstream; in Japan, 80% of corporates have signed up.

“Lots of companies say they can never manage the impact of climate change, but they can — that shouldn’t be an excuse anymore,” Hamm said. “We try and simplify the process so that everything becomes more manageable for businesses.”

There’s little doubt the future is full of scary stuff. Taking things step by step certainly helps. Getting to grips with what it could bring now could save your business dividends 20 years down the line.

This feature was produced by Bisnow Branded Content in collaboration with Willis Towers Watson. Bisnow news staff was not involved in the production of this content.