Expert Risk Articles
Mitigating the impact of increasing losses from weather-related natural catastrophes
AGCS recently brought together risk managers from a number of FTSE 100 institutions in London to discuss the challenges posed by the impact of climate change, the rapid pace of urbanization and increasingly more complex production processes.
Multinational businesses will need to place increasing emphasis on reviewing pre-loss and post-loss risk management in order to mitigate the impact of increasing financial losses from weather-related natural catastrophes in the future, driven in part by climate change.
Changes in the climate and weather patterns have the potential to affect extreme weather events around the world, manifested in three primary ways – more intense windstorms, incidences of heavy rainfall leading to flooding events and more severe drought episodes.
The loss potential for global businesses from such events will be exacerbated by additional risk factors such as rapid urbanization - and the failure of development of sufficient infrastructure to keep pace with this – and the greater interconnectedness of the global economy, resulting in increasing contingent business interruption (CBI) and supply chain exposures, risk managers from some of the UK’s leading companies heard at a briefing on the financial impact of weather events, hosted by Allianz Global Corporate & Specialty (AGCS) in London.
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If natural catastrophe risk management procedures are not in place or have not been regularly reviewed, the magnitude of such losses can increase significantly, according to AGCS.
Dr Rebecca Mitchell, Head of Emerging Markets, UK Met Office, Charles Whitmore, Managing Director and Head of Property Solutions Group, EMEA at reinsurance broker Guy Carpenter, Martin Henson, Regional Head of Claims, AGCS, Clive Trencher, Senior Risk Consultant, AGCS and Dan Tomlinson, Managing Director at Allianz Risk Transfer all gave presentations to risk managers from a number of FTSE 100 institutions at the specialty insurer’s weather risk event.
Climate change “unequivocal”
Climate change is unequivocal, Dr Mitchell told risk managers at the briefing, adding that it is leading to more extreme weather patterns. Natural variability also has an impact, both on short duration events such as windstorms, and long duration events such as prolonged rainfall. In the UK, for example, Dr Mitchell noted that four of the last six summers have been amongst the wettest 10 since 1910.
Meanwhile across Europe it is anticipated that the changing climate will mean that a very hot summer such as 2003, which was the hottest on record in Europe for more than four centuries, could become the norm by the 2040s and be classified as a cool summer by the 2060s.
“How we go about adapting as a society to these sorts of potential futures is something we will need to consider and it is also something businesses will need to consider over shorter and longer timeframes,” Dr Mitchell said.
“Even with a one degree change in temperature we are already into a position of an increased level of risk of more extreme weather events such as heatwaves, droughts and floods.”
Examples of recent extreme events around the world include Typhoon Haiyan in the Philippines, which was the strongest landfalling windstorm in recorded history and Cyclone Nilam, which resulted in India’s south-eastern coast being hit by more than 85mm of rainfall in just three days and causing extensive flooding of the region’s rice crop.
More severe flood events
Eight of the 10 largest historical flood losses have occurred in the past 13 years causing over $100bn in economic damages.
And the trend of the impact of flood events becoming more severe will be further exacerbated by the significant level of urbanization that is predicted to occur in the future.
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By 2050 it is estimated that 68% of the global population will be living in cities, many of which are located in high-risk coastal areas.
Level of investment in infrastructure is unlikely to keep pace with this rapid pace of urbanization, potentially impacting coastal defences, building codes and disaster preparedness.
By 2070 it is projected that all but two of the top 10 global cities ranked by assets exposure to coastal flooding will be in Asia, including four in China alone. Six years ago the top 10 list was comprised of cities in the US, Netherlands and Japan.
China has the biggest flood loss potential for industrial parks, risk managers heard, with 52% at risk of river flooding and 25% threatened by storm surge. The Pearl River Delta alone has higher loss potential than all of Thailand, which in 2011 experienced the largest flood loss in history – costing approximately $50bn in economic damages and over $16bn in insured losses, a significant proportion of which were attributed to CBI losses stemming from thousands of factories owned by multinational companies being inundated.
More severe BI implications
The greater interconnectedness of the global economy is manifesting itself in increasingly more complex production processes with higher economic values. The end result is more severe BI implications. AGCS estimates that BI and supply chain-related losses typically account for 50% to 70% of insured property catastrophe losses, - as much as $26bn a year – but adequate coverage of CBI and supply chain risk exposures remains a gap in many multinationals’ insurance programs.
“The scale of the CBI losses in Thailand took many companies by surprise,” said AGCS Regional Head of Claims, Martin Henson. “Companies still need to spend more time examining their potential CBI/supply chain risk exposure. They put a lot of time into assessing direct damage and looking at their own business interruption (BI) impact but probably not as much as they should do in terms of the risks associated with supplies and customers.”
Interdependencies between suppliers is often a big unknown and it is estimated that only 50% of businesses have alternate suppliers, according to AGCS.
Such losses also highlights the need for more research and resource to be committed to better understanding flood risk, for which there are currently fewer modeling solutions available compared with other natural catastrophe perils.
“Having a flood plan in place – which is a properly documented series of actions – is absolutely vital in the event of a potential flood happening. Flood mitigation can be the difference between a company suffering a serious loss and a catastrophic one,” added Clive Trencher, Senior Risk Consultant, AGCS.
“Death by a thousand cuts”
While such extreme weather events continue to capture the headlines, Allianz Risk Transfer Managing Director, Dan Tomlinson also explained during the briefing how minor fluctuations in expected weather can have a big impact on the financial performances of businesses across a wide range of industries.
“A change in expected temperature over the course of one day is not going to change anyone’s bottom line,” he said. However, a change in expected temperature that lasts day in day out over a whole winter heating season or indeed a whole year will have a cumulative effect on revenue. It is a death by a thousand cuts scenario - a company’s revenue can be eroded over time.”
The economic impact of increasing everyday weather volatility far exceeds the already huge sums annually associated with natural catastrophes. AGCS estimates that the impact of routine weather variation on the European Union’s economy could total as much as €406bn ($561bn) a year. As a comparison, during 2013 the global natural catastrophe loss bill including all weather-related events totalled approximately $125bn.
There is now an increasing awareness and interest in weather risk management tools, which offer a new avenue for companies to create customized responses to the specific weather variables which can affect their business. Using independent weather data, these products are linked to actual fluctuations against pre-agreed weather indices which, when certain criteria are met, can trigger a payment, enabling companies to hedge this risk, similar to the way they might do with interest rate movements and foreign currency exchange rates.
Step 1 Analyze your risks
- Determine the natural catastrophes that could impact your site or sites – for example, earthquakes, flood, hailstorm, windstorm.
- Determine your degree of exposure – assess geographic conditions (should already be part of location evaluation at the time of company/factory/plant set-up)
- Build or retrofit accordingly - incorporate design features to minimize impact of catastrophe/optimize buildings for events like windstorm or flood
- Analyze your business continuity risks
- Check the value chain of your production
- Identify potential bottlenecks and alternatives
- Analyze catastrophe risks of suppliers and customers
- Create a business continuity plan
Step 2 Prepare for the event
- Write your plan – if procedures are not in place or have not been reviewed, the magnitude of a loss can increase significantly
- Create emergency response plan, detailing before, during and after procedures (business continuity plan, communication plan, roles and responsibilities of management)
- Gather additional information in order to promote more specific decisions (for example, severity of flood hazard ie raising high-value stock above the flood level)
- Train your team and review the procedures at least once a year
- Periodic inspections of exteriors, roofs for potential problems
Post-event measures - Objective: To restore operations as quickly as possible
Business continuity plan (resources, contractors, repair, replacement)
- Ensure clients will continue to be served
- Know markets for available replacement equipment and consider purchasing used equipment
- Shift production to another facility, ideally outside the affected area
- Safely shut down equipment so that it is not damaged by water or other natural encroachments.
- Proactively inform clients or suppliers about the situation, ongoing measures and key contact persons in charge
- Proactively inform own organization