With climate change and severe weather events increasingly making headlines, lenders and institutional investors are becoming more interested in how these events are hitting the bottom lines of companies around the world. To answer this question, S&P Global Ratings collaborated with Bermuda-based climate risk management specialist Resilience Economics to determine the prevalence and materiality of climate risk for companies in the S&P 500 index. We examined public corporate research updates and earnings call transcripts from April 2017 to April 2018 (financial year 2017) to identify where a particular weather event had a material impact on earnings. This research complements our environmental and climate look-back analysis “How Environmental And Climate Risks And Opportunities Factor Into Global Corporate Ratings—An Update,” published Nov. 9, 2017.
Climate change will continue to increase the incidence and severity of both chronic and acute weather events, which could lead to a more material impact on companies’ earnings. We excluded from our research the entire financial institutions sector, which includes insurance companies.
In financial 2017, 73 companies (15%) on the S&P 500 publicly disclosed an effect on earnings from weather events, but only 18 companies (4%) quantified the effect.
The average materiality on earnings for the small number of companies that quantified it was a significant 6%.
Climate risk is a surprisingly prevalent topic of discussion for the CEOs of publicly traded companies, and management teams are becoming increasingly accountable for understanding and mitigating the impact of climate risk. Evidence of the impact of climate risk is found across all sectors, geographies, and seasons.
The results of our analysis show that in financial year 2017, 73 companies (15%) in the S&P 500 publicly disclosed an effect on earnings from weather events, but only 18 companies (4%) quantified the effect (see table 1). However, the average materiality on earnings for the small number of companies that quantified it was a significant 6%. In S&P Global Ratings’ view, the effect of climate risk and severe weather events on corporate earnings is meaningful. If left unmitigated, the financial impact could increase over time as climate change makes disruptive weather events more frequent and severe.
Climate Risk and Weather Events Are Top Topics Among the CEOs of Publicly Traded Companies
A review of the earnings call transcripts of S&P 500 companies in the past 10 years revealed that “climate” and “weather” combined were among the most frequently discussed topics among executives, even more common than “Trump,” “the dollar,” “oil” and “recession.”
Discussions of climate risk and its effect on companies’ earnings are now reaching the CEO’s office. Of the earnings calls in financial year 2017 where weather was mentioned as having a material effect on corporate earnings, more than half (53%) of these disclosures were made directly by the CEO. The CEO and CFO combined made 86% of all disclosures of climate-related impact on earnings.
Moreover, CEOs and other top company executives often cite climate and weather as a risk factor beyond the control of management.
The triggers that have induced the insurance industry to innovate have dramatically changed in this millennium. Up until the 21st century, little innovation occurred, because insurers were looking to create products for emerging risks or underinsured risks. Innovation occurred most often as a reaction to claims made by policyholders and their lawyers for losses that underwriters never intended to cover. For example, the early cyber policies, which insured against system failure/downtime or loss of data within automated systems, were created when claims were being made against business owners policies (BOPs) and property policies that had never contemplated these perils. Similarly, some exclusions and endorsements were appended to existing policies to delete or add coverage as a result of claims experience. Occasionally, customer demand led to something new. Rarely was innovation sought as a competency.
Fast forward to today, when insurers are aggressively trying to develop innovative products to increase revenue and market share and to stay relevant to customers of all types. Some examples include: supply chain, expanded cyber, transaction and even reputation coverages.
With sluggish economies, new entrants creating heightened competition, emerging socio-economic trends and technological advances, insurers must innovate more rapidly and profoundly than ever. The good news is that there is movement toward that end. Here is a sampling of the likely spheres in which creativity will show itself.
Insurers have already started to respond to the drone phenomenon with endorsements and policies to cover the property and liability issues that arise with their use. But this is only the tip of iceberg in comparison with the response that will be needed as space travel becomes more commonplace. Elon Musk, entrepreneur and founder of SpaceX, has announced his idea for colonization of Mars via his interplanetary transport system (ITS). “If all goes according to plan, the reusable ITS will help humanity establish a permanent, self-sustaining colony on the Red Planet within the next 50 to 100 years” according to an article this September by Mike Wall at Space.com.
Consider the new types of coverages that may be needed to make interplanetary space travel viable. All sorts of novel property perils and liability issues will need to be addressed.
Weather-related covers already exist, but with the likelihood of more extreme climate change there will be demand for many more weather-related products. Customers may need to protect against unprecedented levels of heat, drought, rain/flood and cold that affect the basic course of doing business.
The insurance industry has just taken new steps in involving itself in the flood arena, where until now it has only done so in terms of commercial accounts. Several reinsurers — Swiss Re, Transatlantic Re and Munich Re — have provided reinsurance for the National Flood Insurance Program (NFIP), for example. Insurance trade associations are studying and discussing why primary insurers should do more in terms flood insurance as a result of seeing that such small percentages of homeowners have taken advantage of NFIP’s insurance protection.
As a single definition for the sharing economy begins to take shape, suffice it to say that it exists when individual people offer each other products and services without the use of a middleman, save the internet. Whether the product being offered is a used handbag, a piece of art or a room in a private house or whether the service is website design, resume writing or a ride to and from someplace, there are a host of risk issues for both the buyer and seller that are not typically contemplated by the individual and not covered in most personal insurance policies. This is fertile ground for inventive insurers. How can they invent a coverage that is part personal and part commercial? Smart ones will figure out how to package certain protections based on the likely losses that individuals in the sharing economy are facing.
So much has already been written about the future of driverless cars, but so many of the answers are still outstanding. How will insurance function during the transition; who will be liable when a driverless car has an accident; who will the customer be; what should the industry be doing to set standards and regulations about these cars and driving of them; how will subrogation be handled; how expensive will repairs be; how will rates be set? A full list of unanswered questions would be pages long. The point for this article is – how innovative will insurers be in finding answers that not only respond to these basic questions but also provide value-added service that customers will be willing to pay for?
The value added is where real innovation comes into play. Something along the lines of Metromile’s offerings for today’s cars is needed, such as helping drivers to find parking or locate their parked cars. Such added value is what might stem the tide of the dramatic premium outflows that are being predicted for insurers once driverless cars are fully phased in.
Corporate Culture and Reputation
Recent events indicate that corporations need some risk transfer when it comes to the effects of major corporate scandals that become public knowledge. The impact from the size and scope of situations such as the Wells Fargo, Chrysler, Volkswagen and other such scandals is huge. Some of the cost involves internal process changes, public relations activities, lost management time, loss of revenue, fines and settlements. Reputation insurance is in its infancy and warrants further development. And though insurance typically does not cover loss from deliberate acts, especially those that are illegal, there is enough gray area in many scandals that some type of insurance product may be practical despite the moral hazard and without condoning illegal behavior.
And the Risk
All innovation poses risk. Risk is uncertainty, and innovation leads to uncertain outcomes. Just as insurers must create solutions, they must be willing to acknowledge risk, assess risk, mitigate risk and prepare for some level of risk to materialize. So, as insurers are now actively trying to innovate, they must make sure that their enterprise risk management practices are up to addressing the risks they are taking.
For each new product, some of these risk areas must be explored:
Is there a risk that projections for profitability will be wrong?
If wrong, by how much, and how will this shortfall affect strategic goals?
What is the risk appetite for this product initiative?
What is the risk the new product will not attract customers, making all development costs wasted expense?
What is the risk that price per exposure will be incorrectly estimated, hurting profitability?
What is the risk for catastrophic or shock losses relative to the product?
How will aggregation risk be handled?
What is the risk that litigation concerning the policy coverages will result in unintended exposures being covered?
Regardless of whether or not they have been dragged into innovation by disruptive forces, insurers are finally ready to do more than tweak products around the edges. The risk of not innovating appears to be greater than the risk associated with innovating.
So goes the famous Australian bush poem by John O’Brien about the plight of farmers going from drought to flood to bush fire – one extreme weather situation after another. And though we are nearly 100 years on since that poem was written, we seem to be no further along in being able to predict weather with any certainty more than a few days into the future. In fact, extreme weather seems to be hitting more frequently and with greater ferocity because of the apparent effects of global climate change. The extended 2013 winter in Europe cost the economy there more than $7 billion – that is just from being cold for a month longer than usual.
Extreme weather events have dominated the headlines, especially where they impinge on highly developed insurance markets such as North America and Europe. But from the perspective of the impact on human lives, the greatest risk lies in Asia and Africa, where a vast majority of people depend upon subsistence farming and there is very little penetration of traditional financial services. A number of governments in the region, in partnership with semi-government, educational institutions and private organizations, have established a range of programs to foster the development of sustainable microfinance and microinsurance services for the most at-risk segments of their communities. In India alone, there are more than 700 million farmers and farm workers who struggle with extreme weather risk every season.
Building sustainable programs, now there’s the trick!
In one program in India that ran from the mid-’80s through to the end of the twentieth century, the cumulative premiums were $80 million, while the cumulative claims were $461 – hardly a sustainable proposition. In another program, a World Bank study showed that the microinsurance proposition was advantageous to farmers only in very extreme situations, so in most cases it was uneconomic for farmers to buy the insurance.
From 2001, the Indian government has ensured the growth of microinsurance through a regulatory framework set up as part of the entry of private insurers into the market. Popular products in the sector are weather index policies, where payouts occur if rainfall is below a trigger level, in a particular area. The premium for these types of policy have proven to be expensive, but, with government subsidies and an education program, awareness and acceptability of this kind of financial service have grown in communities in rural India. Governments in China, Bangladesh, Indonesia and the Philippines are following suit, by introducing their own agricultural insurance programs.
The major problem for insurers writing this kind of business is getting a good handle on the risk, to enable correct pricing. For the most part, insurers have to rely on historical data, which really only establishes a wide range of outcomes; with extreme weather trends continuing, insurers tend to be very conservative in risk pricing.
This is where big data and analytics come in.
In the commodities sector, at least one player has marketed reports that help predict the price of commodity futures. A case in point is the recent U.S. drought. By using National Oceanic and Atmospheric Administration (NOAA) and NASA remote Earth-sensing data, and coupling with advanced climate predictive analytics, the U.S. drought was predicted three months in advance of the U.S. government’s declaring drought. The model enabled the assessment of the weather impact on particular areas of the U.S., as well as the impact on the particular commodity crop grown in that area (corn), and, consequently, a prediction of the price of the commodity at harvest time based on the expected overall yield, with drought factored in.
Currently more than 15 petabytes of public data is produced annually that is global in nature, and the amount of data is set to increase to more 300 petabytes as more satellites come on line over the next few years. The computing power and technology to cope with huge data sets continues to improve each year with big data solutions.
These rich data sources and new technology solutions represent an unparalleled opportunity for governments and communities to turn microinsurance from a subsidized, unprofitable activity, to a sustainable model to spread economic stability and prosperity. By enabling the weather risk to be more accurately modeled, underwriters will be able to price policies on a more accessible basis.
Studies are showing that, where microinsurance is in operation, microfinancing is supported, as farmers can have certainty around being able to meet their loan commitments. These financial services are being used by farmers to improve their farms’ yield by investing in appropriate weather risk mitigation (irrigation, soil moisture conservation, etc) and productivity enhancements (planting automation, genetically modified seeds, fertilizers, improved pest control, etc). This virtuous cycle lifts this sector from depending on subsidies and government programs to being commercially viable and self sustaining. Definitely a win, win, win proposition.
Far from the pessimistic, doom-mongering of Hanrahan, I see a world more in line with Peter Diamandis’s vision as outlined in his book Abundance: The Future Is Better Than You Think.
I don’t know about you, but I for one would love the bragging rights to say my industry is helping to improve the lives of billions on planet Earth, while still making a commercially reasonable profit.
Over the next few days, you’re going to read a number of comparisons between the current Hurricane Sandy and August 2011’s Hurricane Irene. Firestorm urges you to read and take these comparisons seriously, as Irene killed 56 people with US costs upwards of $15.6 billion in damages. The total damages are still being felt.
Sandy, sadly, has the potential to be “the Perfect Storm.” Some meteorologists say a rare combination of events — Hurricane Sandy combined with an outbreak of unseasonably cold air, and a strong land-based storm system — could deliver flooding rains, damaging winds of near-hurricane force, large waves, and even heavy snow inland.
This Public Discussion details meteorological observations as of 5PM Thursday evening, 10/25:
“…Later in the period … some re-intensification is shown as Sandy deepens again off the U.S. East Coast while it interacts with another shortwave trough. Regardless … Sandy is expected to be a large cyclone at or near hurricane intensity through most of the forecast period.
“… Sandy will be pulled northwestward and slow down on Friday while it interacts with the upper-level low. Then a north-northeastward acceleration is expected by Saturday as a long-wave trough move into the eastern United States. Most of the track models now show a turn back toward the northwest by the end of the period due to Sandy interacting with an amplifying shortwave trough over the Carolinas and mid Atlantic states. However … there remain some significant differences in the timing of this interaction … as the ECMWF has Sandy farther west and interacting with the shortwave sooner relative to most of the rest of the guidance … which shows a wider turn and a track farther north. The new NHC forecast is close to the previous one … and lies roughly between the ECMWF and the GFS ensemble mean. Regardless of the exact track of Sandy … it is likely that significant impacts will be felt over portions of the U.S. East Coast through the weekend and into early next week.”
Firestorm’s Jim Satterfield states:
“While Sandy’s pattern is similar to last year’s hurricane, the water temperature is lower and wind impact may be less. Even given lower winds, flooding is extremely likely and combined with down trees and the possibility of ice, loss of power is expected as the hurricane moves inland. For businesses, now is the time to reconfirm call in numbers and messaging. The European model shows that Sandy has the potential to become a massive storm. If this model is correct, outages could be in days and even weeks.”
As reported by the Associated Press, Massachusetts Gov. Deval Patrick said he expected to receive by Friday from the state's major utility companies, emergency plans for how they will deal with the storm.
The utilities came under intense criticism last year following widespread and long-lasting power outages caused by the remnants of Hurricane Irene in August and a surprise October snowstorm.
Asked during his monthly “Ask the Governor” show on WTKK-FM if he expected utilities to be more prepared for this storm, Patrick responded: “They'd better be.”
Patrick signed a law earlier this year that requires utilities to dramatically improve communications with their customers during emergencies. Many residents and municipal officials in areas hard-hit by last year's storm complained that they were unable to get accurate information from companies about when power might be restored.
The law requires the utilities to establish call centers that would be staffed around the clock after major storms to handle inquiries from customers about power restoration. Failure of any investor-owned utility to carry out an order by the chairman (authorized under section 4B of the General Laws of the Commonwealth CHAPTER 25 DEPARTMENT OF PUBLIC UTILITIES) shall be subject to investigation and a penalty of up to $1,000,000 per violation.
In a statement from Governor Andrew M. Cuomo on the NY-Alert website, the Governor directed the New York State Division of Homeland Security and Emergency Services to closely monitor the progress of Hurricane Sandy and prepare for potential storm impacts. Although the storm track is still uncertain, Hurricane Sandy has the potential to affect many parts of New York State with a variety of threats, including heavy rain, high winds, flooding, tornadoes, coastal surges, and widespread power outages.
“I have directed state agencies and New York's emergency operations personnel to begin preparations now for the potential impact of Hurricane Sandy,” Governor Cuomo said. “I urge all New Yorkers to closely track the storm's path, using local radio and television or online reports. We will actively monitor the storm's progress and take any steps necessary to protect our state's residents.”
Connecticut Light & Power (CL&P) is hiring 2,000 contractors from the Midwest and United Illuminating is hiring hundreds of workers to help respond to Sandy if the storm hits the state. CL&P provides power to more than a million residences and businesses, and is warning its residential customers to prepare a home emergency kit and has begun reaching out to local officials to update them on how the company will respond if there are widespread power outages.
In Maryland, Baltimore County government is holding an emergency preparedness press conference at 1:30 p.m. Friday, in which county emergency personnel will update residents on response plans and Baltimore Gas and Electric Vice President for Corporate Communications Rob Gould will detail the utility company's preparedness plans.
Businesses Should Prepare Now Firestorm Solutions, a nationally recognized leader in Continuity Planning, Critical Decision Support, Crisis Response, Crisis Management, Crisis Communications, Crisis Public Relations, and Consequence Management, urges businesses to review business continuity plans, and to communicate with employees and vendors to prepare for labor shortages, supply chain interruptions, power and technology systems back-ups, and other critical system and process interruptions:
Recovery prioritization structure for critical business functions
Response and recovery actions by functional department
Identification of critical suppliers
Identification of key employees and contacts
The crisis management team should include the CEO, senior officers, and key personnel representing operations, security, marketing, human resources and public information. The senior business continuity officer and his staff facilitate the crisis management discussion and decision making.
Depending on the severity of the crisis, a command center is set up including PC's, white boards, and phone lines. As status information flows into the command center, it is useful to record it on the white board for the crisis team to see at a glance.
Roles and Responsibilities in a Crisis
Human Resources is charged with updating employee information phone recordings and web site with status and instructions.
The security officer should communicate with fire and law enforcement, if necessary.
Marketing should develop customer communications, and public information should craft carefully worded statements for the media/social media outlets.
It is imperative that media inquiries be referred to an experienced, designated spokesperson.
The secretary to the board or CEO should inform directors, when appropriate.
The command center is staffed around the clock, and team members are rotated until the crisis passes and full recovery is completed.
Time is of the essence in crisis management, and it deserves its own plan specifying participant responsibilities. A measure of success is that the dimensions of the crisis are known and recovery activities are begun within the first few hours. In the absence of a tested crisis management plan, the crisis management process can be a turbulent and reactive instead of a calm and productive experience.
Incident/Emergency Response Plan
Implementing an emergency response plan enables a timely response to a disruptive event, with the objective of protecting people and property, while enabling an efficient recovery effort that satisfies stakeholder expectations. Firestorm's Emergency Response Team, which can be reached at 800.321.2219, is available to assist with:
Establishing emergency response objectives and assumptions.
Developing emergency response team roles and responsibilities.
Identifying primary / alternate assignments.
Collecting emergency response team contact information and documenting call tree procedures.
Designing a triggering process, escalation criteria and declaration criteria; establishing and documenting authority levels.
Documenting actions by phases, disruption or crisis for incident response at the impacted site.
Documenting or attaching evacuation and shelter-in-place procedures.
Developing and documenting response procedures that align to the emergency response objectives and assumptions; developing processes to enable recovery procedures.
Establishing and documenting communications strategies to internal and external resources/ stakeholders; summarizing media handling procedures; documenting crisis communications holding statements.
Creating a damage assessment process and assigning personnel.
For Business Preparedness
The Firestorm Hurricane Sandy Business Crisis Management Response Team is available now at 800.321.2219.