The Risks of Climate Change for Business

By: William Buist on : 29th December 2015: Business Design, Business Model, Business articles, Strategy: 1 Comment

In 1987 I took a job with General Accident Insurance company in Scotland, I was hired by Dr Andrew Dlugolecki and for two years worked with him analysing exceptional losses. That analysis was primarily used so that the insurer made sufficient provision for rare events and made decisions about buying reinsurance – insurance for insurers.  Rare events, because they are rare, need special treatment in an Insurers analysis. Some of the premiums need to be ‘banked’ each year so that when the unusual event happens there’s sufficient money in reserves to ‘smooth’ the impact on the Insurers balance sheet. Reserve too much and you constrain growth, too little and you damage the balance sheet, so getting it right is important.

We were analysing weather losses, individual events, and how they converted into claims costs for the insurer. That’s not the same as climate change where trends are analysed over long periods of time. In the short term weather is variable and extremes are just random events, but when you study them over long periods of time (and look at other datasets to analyse trends) new insights start to emerge. What we started to see though was what Dr Dlugolecki described as the “fingerprint of climate change” The trends in extremes related to warming, e.g. more energetic storms, higher single day rainfall totals, were rising, and the trends in cooling extremes, such as extended periods of cold, were falling.

In the mid 1980’s Dr Dlugolecki and his team were becoming clearer that both the severity and frequency of these rare events was changing rapidly, in short, they were becoming less rare. He continued his analysis throughout my time at General Accident (later AVIVA) and he and I had the pleasure years later (2009) of working on the Chartered Insurance Institute’s last paper on the topic  “Coping with climate change” (link: https://www.cii.co.uk/knowledge/policy-and-public-affairs/articles/coping-with-climate-change/22989)

What became apparent (and is described in chapter 4 of that report) is how catastrophe modelling (the work we were doing in the mid 1980’s) and climate modelling were aligned. In the intervening period many indicators showed that events that had been “once in a lifetime” extreme’s were becoming once in a decade. Risk management through things like flood defences for the one in 100, or even one in 250, year events would soon be insufficient for quite regular events.

The evidence of extremes becoming more extreme, and more frequent has continued to mount in the ensuing years (see Munich Re’s brief here: https://bui.st/s/4c).  That has implications for businesses, particularly those in areas where change is likely to affect them directly, for example by flooding, but also in general for all businesses.  This article published after the early 2014 floods is interesting in the light of the current political reaction to the late 2015 flooding in the North of England. https://therationalpessimist.com/2014/02/15/uk-floods-dont-say-we-werent-warned-part-1/

Considerations

Directly extrapolating insurance losses to climate change can’t be done.  Climate is a complex massively multivariate issue that’s historically short of recorded data points and yet needs long term data analysis to gain certainty. It’s an ‘experiment’ being run at a global scale and so can’t be recreated to test any individual result’s repeatability (as many standard scientific discoveries have done as part of ‘proof’). Change takes place over long periods in which there is a lot of variability and randomness. It’s influenced by some drivers and factors that remain poorly, or not at all, understood.  So scientists have to theorise, model and test those models against observations that are, or were, taken for other purposes. All of that is difficult and open to challenge. It’s expensive work that doesn’t lead directly to a commercial result, so it’s often funded by government and those whose industries are likely to be affected by the conclusions, positively or negatively. That leads to inevitable skepticism about the independence of the science. It shouldn’t.

There are some elements that are clear, including:

  • Currently more carbon dioxide is being released into the atmosphere, by mankind, than at any time in human history. Atmospheric Carbon is now above 400 parts per million (PPM); higher than any atmosphere analysis from bubbles trapped in ice core records going back over thousands of years.
  • Carbon Dioxide is a greenhouse gas. Higher concentrations reduce the transmission of heat to space, but don’t restrict the Sun’s inbound energy. The additional heat is held in the atmosphere, landmass, and oceans, yet the heat capacity of the oceans is significant higher.
  • Higher sea surface temperatures are strongly correlated with more energetic storms. (Which links us back to the work on insurance losses).

Many other aspects are far less clear, for example, the impact of melting sea ice on ocean circulations is hard to model, the generation of haloclines and thermoclines and their impact, other external drivers such as solar activity, the impact of loss of rainforest, other random variation and so on.

As the science develops models that are more complex, and more reliable, are being developed. What we can’t do is say with provable certainty that the models we now have are right, indeed we know they are not. They are a tool in helping to determine likely outcomes and the impact of policy change. They provide insight into the mechanisms by which climate change can happen. In my judgement climate is , and always has been, changing, but the activity of mankind is having a significant and detrimental effect on the climate and will continue to do so for generations to come.

So what does that mean for business and how should we act as business people within that context?

Strategically some things are aligned which can be done and make sense to do immediately. Controlling our use of energy, be that in heating, lighting, travel and other activity should be monitored and optimised. That has an immediate impact on costs of doing business and profitability.

We need to think through how our products and services will adapt as the world changes as a result of  both climate change and national and international policy and legislation that results. The needs for our products and services will change in that developing market landscape, so the products we sell, and the products we buy will adapt too. From a strategic viewpoint whilst change is happening quickly it’s not fracturing the marketplaces of the UK; we have some time to prepare and adapt.  The COP21 talks in Paris brought universal agreement by all countries for the need for action on climate change, and that reduces the wriggle room for policy makers. Change will follow and we all need to be aware of what they do, how it affects businesses, and take it into account in the business planning processes.

Technologies are shifting the ways that we work, with elements moving to internet and electronic formats quickly. Embracing those changes for customer service, as well as product and service delivery may be significant in shifting the strategic direction of many businesses. I suspect that just as we look back on our parents generation and wonder how business was done by letter and typing pool, so our children will look back on now and chuckle at email and hangouts.

There are risks with all that too. All new technologies have learning curves and unexpected side effects. The chapter in the CII report that I authored covered sustainability. I highlighted that some early ‘low energy’ bulbs transferred CO2 pollution from the lifetime of usage to time of manufacture, and from the UK’s CO2 balance sheet to other countries. Reflecting now, most of that first generation technology has now been replaced with LED technology which is even more efficient and doesn’t have the same manufacturing impact. We probably couldn’t have got to that technology as quickly without the intermediary steps. So we have to be prepared to take steps and change direction if our choices lead us into a blind alley, or false dawn. That’s a strategic skill that needs care in delivery.

Conclusions

Loss is a real thing, not something that insurance eliminates or businesses just swallow, there are consequences however it is handled. Insurance means that the loss is distributed amongst the community, roughly in proportion to the risk we each bring to the pool, and ensures that catastrophic events fall on broad shoulders not narrow ones. If the frequency of big losses rises, or their cost increases, then either insurance costs rise and/or the events become uninsurable. We always have a fiscal drain on the economy from the losses.

Strategically, if individual businesses act in isolation and treat their insurance costs as a fixed cost we collectively miss an opportunity to reduce business costs generally and reduce the collective profits of business, so there’s good reason to minimise risk.

Taking time to consider how big issues can often seem beyond our individual ability to influence. Yet they do affect our ability to do business, so if we change our behaviours and adapt our business model in a considered pro- rather re- active way our own businesses become more sustainable. When we all do that in a coordinated and market wide way the actions do influence the whole. Collective speed needs guidance and co-ordination from Government, which is lacking and often misguided.

That should not stop any of us making appropriate, informed, strategic decisions carefully and with our sustainable futures in mind.  I don’t think it’s good enough to ignore the need to  change the way we do business, whilst businesses must build profits, sustainably, they should also tread lightly whilst doing so. Strategically that’s not just a good growth strategy for the business, it’s good for society, good for us all.

Further Reading (by no means exhaustive …):

NASA – Climate change evidence : https://climate.nasa.gov/evidence/
NOAA – State of the climate : https://www.ncdc.noaa.gov/sotc/
Munich Re – Economic trends – insured losses (pdf) – https://bui.st/s/4c
CII: Coping with climate change (2009) -: https://www.cii.co.uk/knowledge/policy-and-public-affairs/articles/coping-with-climate-change/22989
RationalPessimist ; https://therationalpessimist.com/
Skeptical science : https://www.skepticalscience.com/
IPCC : https://www.ipcc.ch/
UK government policy: https://www.gov.uk/government/topics/climate-change
Committee on Climate Change: https://www.theccc.org.uk/tackling-climate-change/
Index of climate data sources: https://www.realclimate.org/index.php/data-sources/
Mean sea level : https://www.psmsl.org/
National Oceanography Centre : https://noc.ac.uk/



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