Sharing the risk

Climate change means more natural disasters, which presents increased risk for business and the community as insurers feel the pressure. Something has to change. 

Once we called them acts of God, or if you prefer French, force majeure — incidents that human beings regarded as being not only beyond their ability to control, but beyond their ability to predict. Unforeseeable and therefore unpreventable.

Companies looked at these risks, catastrophic as they could be, and did their best to shift them to someone else. The primary way they did this was by taking out insurance. Business leaders and company directors could be expected to know and predict many things — the state of their market, the movements of their competitors, the needs of their customers. But one thing we did not expect them to be able to predict, prevent or protect against was the weather — and the seemingly-random expressions of it that we call natural disasters.

If that was ever an appropriate way to think about risk, it isn’t now. In a world dominated by the rolling reality of climate change, disasters like floods, fires and storms have long since ceased to be unforeseeable, if indeed they ever really were. Yet, too often, we still think and act this way. When floods inundated much of northern New South Wales in 2022, the most surprising thing was how many Australians professed themselves surprised. A sign of nature’s fickle unpredictability, intoned TV reporters. A “once in 500 years event”, declared political leaders.

These are ideas we need to shake loose right now, because they will cause real damage if we allow them to persist. With a return to El Niño conditions forecast for the next Australian summer, can we really say it will be defensible to be taken by surprise if drought and bushfire rear their heads again?

Climate change means disaster events are happening more often. That simple fact brings into stark relief existing shortcomings in foresight, planning and resilience — and signals the need for a fundamental shift that Australian businesses need to make. It’s time for a conversation about what it means to genuinely share risk.

Time for a step change

In a report co-authored for the University of Cambridge Institute for Sustainable Leadership, we propose a step change in how risk is shared by insurers and others in what we call the “risk system”. The report sets out a worrying trend in how risk is increasingly being managed in a climate change world.

There are essentially three ways in which risk is commonly shared when it comes to things like natural disasters. The first is the one already mentioned — via the global insurance system, as individuals and businesses pay premiums in exchange for specified cover when damage and loss occur.

The second is via governments, which are commonly called upon in the wake of disasters to provide emergency response, support payments, reconstruction funding and other ways of propping up communities and businesses that have suffered loss.

The third — most often ignored — are the private individuals and companies, who in many cases must simply absorb their losses and attempt to move on.

What we are increasingly seeing in the climate change era is the migration of risk — and therefore losses — from the first of these (insurers) to the second and, most worryingly, third groups. In the Northern Rivers floods in NSW, insurers paid claims of around $5b — a figure that is highly regulated, fully disclosed, easy to track and analyse. It’s estimated that the losses for government, private citizens and businesses were three times greater at $15b — an amount that is not only much larger, but largely unreported, little understood and utterly opaque.

We are seeing, in real time, a transfer of risk back onto businesses and individuals, with governments as a safety net. In which case, the costs are passed back to businesses and individuals anyway, via the tax system.

In this context, the federal government has recently announced a new review into how it funds disaster response, recovery and resilience, to be helmed by former National Bushfire Recovery Agency chief Andrew Colvin APM OAM. The review is born from recognition of an emerging truth — unchecked and unaddressed, this shifting of risk can have a hugely damaging impact on our economy and our community.

It is a truth that company directors and business leaders cannot afford to ignore. As climate change impacts worsen, businesses and individuals who are highly exposed will face ongoing escalating premiums or even have coverage withdrawn. In some cases, they may find themselves effectively uninsurable. If you operate in a sector or location that is particularly exposed — or rely on commodities or investments that are — this could easily be your future. The good news is that there are things you can do.

Real risk sharing

The step change that we need to see starts with understanding and accepting that increasing resilience is a necessary task for all who play significant roles in our economy and society. We need transformation across many different areas — the buildings we’re based in, the processes and commodities we use to manufacture things, the infrastructure we rely on, the way we source and use energy, and where staff are located and how they work.

Climate change impacts all aspects of society and all parts of our economy. That means we need a far more holistic approach to dealing with the risks it throws up, one that not only acknowledges the interconnectedness of businesses, governments, citizens and insurers, but leverages it to become a strength.

Otherwise, we are not just exposing our businesses to the impact of disaster events, we’ll likely be making things worse for others. Take those NSW floods for example. A collective failure to apply appropriate foresight, plan effectively and build resilience actually compounded the impacts of rising flood water for those who experienced them. Tens of thousands of people were cut off without electricity, phone and internet services — some for weeks. Empty supermarket shelves and petrol station bowsers added to the chaos.

What does genuine risk sharing look like?

There is plenty that Australian companies and those who lead them can learn from the insurance industry, which is generally more experienced when it comes to assessing and dealing with climate risks. Insurers are a great source of intelligence when it comes to climate risk, a resource that remains largely untapped. We need to see more open sharing of data and information with businesses. Where is a company exposed? What changes could its leaders make to increase the resilience of their business and therefore reduce their risk and their premiums?

Another thing corporate Australia can learn from the insurance sector is to take a longer- term view. Many businesses still consider their financial outlook using horizons of three to five years. The challenges of climate change mean this is no longer adequate. You need to have a clear picture of how your business is set up to be functioning in 2030 and 2050. Changes you start making right now might take a decade to be recouped, but could also be critical to your survival or prosperity in the longer term.

This same long-termism needs to be employed when it comes to assessing and mitigating risk, which is still often aligned with the shorter time frames we use for whole-of-business planning. Companies that flourish will be those who take an intergenerational approach to risk assessment, identifying future legal, fiduciary and financial liabilities in time to do something about them.

Businesses that do not know or cannot say what their resilience to climate risk or what their future carbon footprint will be — ideally in the form of a carbon budget — will be at far greater risk of becoming uninsurable or facing crippling premiums. The insurance industry, like banks and investors, will need to work with regulators to create and entrench such budgets in the underwriting, credit and investment processes. Without them, there cannot be a clear view of risk.

We also need to see a greater alignment between real levels of risk and premiums.

If insurers can work with businesses and individuals to identify measures they can take to reduce their exposure — such as making buildings more storm or fire resistant — the risk exposure will be reduced and benefits should be shared. The same logic could deliver lower premiums for businesses that reduce their carbon budget.

Finally, we need to see and act on the whole of the risk environment. That means having greater visibility of the uninsured and what risk looks like to them. In many cases, there are important things they can and should be doing to limit their exposure, outside of insurance. For example, in some circumstances, it could make sense for a business to avoid paying flood insurance and to instead invest that money in flood-proofing its premises.

It is often said that we find ourselves in the “defining decade” when it comes to our collective response to climate change and the associated risks that accompany it. In response, last year the AICD launched the Climate Governance Initiative (CGI) for company directors. Partnering with industry experts, this collection of practical webinars, newsletters, and governance guides is a rich resource that is lifting director capability and insight on climate risk and opportunity.

The message for company directors should be clear and urgent. Not everybody will emerge unscathed — or perhaps emerge at all — from this defining decade. However, those who think beyond that time frame, and act and plan accordingly, can not only survive but prosper in the emerging low-carbon economy.

Geoff Summerhayes GAICD chairs Zurich Australia & NZ, Beyond Zero Emissions and the CGI Australia steering committee. He is a senior adviser at Pollination and a former board member of the Australian Prudential Regulation Authority.

CGI Australia is a multi-partner collaboration aimed at supporting effective climate governance by Australian boards. Practical resources from CGI Australia can be found here.