In June 2021, the finance ministers of the Group of Seven (G7) leading nations called for disclosure of climate-related financial risks to be made compulsory for companies. France has already made it mandatory for companies to report climate risks.
This is part of a wider move by investors, financiers, regulators, shareholders, and other stakeholders to get better disclosure on climate change matters.
Significantly, these stakeholders are challenging entities who are not factoring the effects of climate change into their critical accounting reporting and decision making. As the Task Force for Climate-Related Financial Disclosures (TCFD) puts it:
“Investors, lenders, and insurers don’t have a clear view of which companies will endure or even flourish as the environment changes, regulations evolve, new technologies emerge, and customer behavior shifts — and which companies are likely to struggle.”
So why are these various stakeholders concerned about disclosure on climate-related financial risk and how does this relate to your sums insured?
Impact on physical assets
Physical risk, meaning an organization’s vulnerability to climate change, can be divided into:
- direct risk, which includes event-driven or longer-term shifts in climate patterns, supply chains or operations (for example rising sea levels, avalanches, extreme heat, etc.), and
- indirect risk which covers the broader natural, economic, or human environment (migration, human health, license to operate, etc.)
Both these direct and indirect risks could have a number of effects on physical assets, and their corresponding value to an organisation, including: –
- changing assumptions in forecasts so impacting asset values based on cashflow forecasts
- affecting the useful life of assets
- increasing operational costs and hence profitability of assets
- increasing asset retirement obligations
- reducing the accessibility to, or increasing the cost of, financing
- creating new asset impairments.
Given the potential impact on values, you can see why stakeholders are increasingly pushing to have climate change scenarios modelled and factored into executive decision making.
Why accurate values are important
In a recent article, the global professional services firm EY states:
To satisfy their stakeholders, organizations should be able to articulate the relative size and time frame around physical and transition risks in their geography and industry, ideally constructing worst case, base case, and most likely case scenarios.
But to achieve this, owners need accurate information on those assets including the current reinstatement cost.
With values-at risk rarely being assessed correctly, owners and others attempting to model these scenarios and identify the associated risks are in danger of arriving at dubious conclusions.
Impact on insurance?
But as well as ensuring that current sums insured are correct to allow for accurate scenario planning, there are several other issues that stakeholders may increasingly need to take into consideration: –
- How to set the values at risk for an asset when you may not be allowed to reinstate the asset or facility as it is?
- How to set the values at risk when you may not be allowed to reinstate the facility in the same location, or even region?
- If the useful life is shortened, is reinstatement the appropriate basis or should you consider actual cash value or indemnity as the basis to insure the facility?
- Is the current capacity/function of the facility what you would require in the event of a loss? Or should you insure on an alternative replacement basis?
- If investment or financing in certain industries declines, will this impact the availability of suppliers and contractors? Could this push up reinstatement costs? Or possibly make reinstatement unviable?
- For large projects, how do you reflect the impact of possible delays to reinstatement due to increased environmental legislation, increased activism or the risk of additional controls being implemented during rebuilding?
As the Economist Intelligence Unit said in its 2015 Report – The cost of inaction: Recognising the value at risk from climate change – “Imperfect data availability and patchy admissions on climate risk leave both regulators and institutional investors unable to adequately address …risks.”
For more details on how John Foord can assist with filling information gaps on values, please get in contact with us: