6 Non-Cyber Risks for Technology Companies
The Risk List is presented by:
Building Resiliency in the Face of Climate Change
Failing to prepare for extreme weather events cost the United States $1.15 trillion in economic losses from 1980 to 2010, according to the U.S Global Change Research Program (USGCRP). The more telling number comes from a study by Munich Re, which put insured losses for North America during the same period at $510 billion. No doubt government was forced to take on the lion’s share of the rest, but U.S. business also paid out of pocket for a fair amount of the remaining $640 billion in losses.
Here’s another sobering figure. A Business Continuity Institute study indicates that 40 percent of businesses affected by extreme weather for extended periods of time never recover or reopen. It’s likely that for much of the 60 percent that stay open, full recovery is a long and painful process.
The forces behind these events are gaining steam and they are indiscriminate. From December 2013 through February 2014, drought-stricken California recorded its warmest winter on record. Across the rest of the country, including the South, winter storms were merciless, dealing at least a $15 billion blow to U.S. businesses.
Let the politicians bicker all they want about who or what is to blame for climate change. USGCRP projects another $1.2 trillion in losses through 2050. So for those with boots on the ground and a business to run, it doesn’t matter who’s to blame. Climate change is not a future risk, it’s a right-now risk, and the only question that matters is, “Now what?”
Some of the answers to that may surprise risk managers and other business leaders.
The Chocolate Elephant
Here’s what’s on the table. According to the most recent report from the United Nations’ Intergovernmental Panel on Climate Change, ice caps are melting, sea ice in the Arctic is collapsing, water supplies are coming under stress, heat waves and heavy rains are intensifying, and coral reefs are dying. Coastal communities are under double threat from sea-level rise and from increased acidity as the waters absorb the carbon dioxide given off by cars and power plants. Organic matter frozen in Arctic soils since before civilization began is melting, decaying into yet more greenhouse gases.
Video: A description of the IPCC findings.
Slowing these trends may be possible, but reversing them is not. Therefore, the altered climate — with its attendant storm frequency increases, droughts, wildfires, intense rainfalls, storm surges, the “polar vortex,” the rising sea level and the rest of it — is ours to keep.
Evidence of this mounts daily. Just within the days surrounding the 2014 RIMS conference, wildfires ravaged states on the East and West coasts, tornadoes ripped a path across the South Central United States, and severe floods battered Florida and Alabama. That convergence of calamities no longer seems to strike anyone as shocking. In the years and decades to come, these events are expected to increase in both frequency and severity. In other words, welcome to the new normal.
Superstorm Sandy tested the mettle of many, and served as a wake-up call to those who underestimated the complexity of the climate risks they face. Organizations were brought up short by just how underprepared they really were — and what that could mean to their bottom lines. Risk managers, both public and private, are beginning to parse out what climate change really means and what its total implications are for the organizations they serve.
That task can seem daunting. There are multiple perils involved, which have an exponential impact on possible exposures.
“One of the challenges of climate risk is that for most people, it’s the chocolate elephant — it’s just too big to eat,” said Chris Smy, managing director and global practice leader with Marsh’s environmental practice. That makes it tempting to throw up one’s hands and say, “I can’t solve this.”
The threat seems both too large and too distant. Many reports and articles about climate change include the phrase “by the end of the century …” easily lulling leaders into thinking of it as something that need not be addressed right now, especially when matters such as cyber risk seem so much more immediately pressing.
But the increased frequency and severity of extreme weather events is apparent. At the same time, we’re seeing populations gravitate toward cities, and scientists have concluded that cities are warming at a faster rate than rural areas. These facts alone make for a dangerous combination. The population shift toward urban areas also means that many companies don’t have the option to avoid doing business in exposure-prone areas. They need to be where the customers are.
“You have more frequency and severity, and that is exacerbated by more people at risk and more assets to be damaged,” said Bob Petrilli, head of North America, Swiss Re Corporate Solutions. “It’s a triple whammy — it’s multiple economic issues coming together to make things that much worse.”
In the face of these challenges, a dialogue has begun among both corporations and public entities about the concept of resiliency and how to achieve it. What “resilience” means will be different for every company. But it must encompass both the means to minimize exposures and to plan for all contingencies, as well as a clear roadmap to recovery.
Assessing exposures surrounding climate risk is a more acrobatic exercise than some risk managers are accustomed to. It will take a deep dive into the “what ifs” of each possible peril, looking beyond clear property risks and into anything that could impact a company’s supply chain, as well as a thorough examination of factors that could create business continuity disruptions. For diligent companies, that sounds like standard best practices, but climate risk gives it a new flavor many have not yet tasted. What if the increased frequency of storms, over time, erodes the reliability of power delivery to one or several of my facilities? Could storm surge threaten any of the key bridges we use to transport products out or bring raw materials in? What if there’s a lack of potable water in the city where my key factory is located, or their food supply is sharply diminished by drought conditions? What if threats to the food or water supply create new diseases that incapacitate a large percentage of my workforce in that region?
“One of the challenges of climate risk is that for most people, it’s the chocolate elephant — it’s just too big to eat.” — Chris Smy, managing director and global practice leader, Marsh
That’s not to say that companies need jump on every risk identified. It’s a matter of eliminating the element of surprise. “The horizon may be different,” said John Marren, director of global risk and insurance management for CSL Behring, at a session at this year’s RIMS conference, “but we wanted to have it all on the radar.”
A New Discussion
As companies confront the real problems posed by climate risk, the more they will be faced with the reality that individual companies cannot effectively mitigate every aspect on their own.
“What we’re finally starting to notice is a shift toward this idea of comprehensive risk management,” said Alex Kaplan, vice president, global partnerships for Swiss Re. “It’s not just about your own resilience but it’s also about the community around you. For instance, if you have, say, a corporation that’s based in a city. They could have state-of-the-art technology and could be insured to the teeth, but the city around them ends up collapsing.”
A poignant and very real example of this, said Kaplan, is the Toyota plant in the Turkish city of Van. “It was up to the most incredible standards of seismic protection. So when they had an earthquake in 2011, the factory was virtually unscathed.” However, Kaplan explained, 600 people in the surrounding community were killed, 6,000 buildings were destroyed and 60,000 people were left homeless. “So even though Toyota was physically OK, none of its workers could get to work. And frankly, even if they could get to work, they probably had bigger problems to worry about.”
The corporation with the best risk management, the best strategy and the best risk transfer still has to be aware of where they’re located and what around them could also be impacted and prevent them from moving forward, said Swiss Re’s Petrilli.
“A corporation can’t really survive and thrive unless it’s in a location that has a resiliency plan, and if you’re not talking about that together, then you’re never going to get there,” he said. “This public-private partnership type of approach and thought process is relatively new to our industry — but I think it is critically important.”
These ideas — which are spreading slowly — represent a fundamental shift in how climate risk is perceived.
“Many of us in the industry have been focusing on not just the idea of resiliency but on this overarching concept of enterprise risk management, but it’s also broader, it’s global, it’s about interconnectedness,” said Lindene Patton, chief climate product officer at Zurich.
However, she added, “People are not accustomed to thinking that broadly.” So, no doubt, there are some that are going to balk at such a bold departure from tradition. Put in perspective, though, it’s only a logical step for companies that are already engaged in their communities from a corporate citizenship standpoint.
“Corporations like to be integrated with the communities they’re in, they support things within the community to raise their own stature,” said Petrilli.
“But they probably haven’t in the past met with the city or the municipality from a risk management standpoint to discuss things like ‘What if this? What would we do?’ Once that dialogue starts, it becomes more of a ‘We’ve all got a dog in this fight’ conversation.”
Experiencing the pain of losses will increasingly drive organizations toward this perspective.
“A corporation can’t really survive and thrive unless it’s in a location that has a resiliency plan, and if you’re not talking about that together, then you’re never going to get there.” Bob Petrilli, head of North America, corporate solutions, Swiss Re
A good example, said Marsh’s Smy, is how, since Superstorm Sandy, there’s been a lot of activity in the New York tri-state area around trying to prepare, as a region, for repeat events of that magnitude.
“There’s an opportunity for organizations to engage with local government,” he said.
As organizations look through the lens of climate risk as a way to assess their risk profiles, they’ll begin to recognize that there are areas they can’t control, said Smy, “and they may well decide, ‘We can no longer be a bystander.’ Once you reach that conclusion … then there’s action that can be taken.” That may take the form of lobbying for changes, investing money in nonprofits conducting resilience studies, seeking out public-private partnerships, or even investing in infrastructure.
“The more we talk, the more we get to the point where there is a joint approach to an event,” said Petrilli. “It kind of screams for some collaboration.”
At the very least, opening a dialogue will help flesh out the breadth of the exposures so that action plans can be developed around them. “What people are beginning to focus on is sharing information and on the idea of public-private partnerships,” said Zurich’s Patton. “[It’s about] trying to just define these externalities … Does the power work? Can you drive down a road? Can you get gasoline? Is the metro running? Those are all questions we’re not used to asking. We’re used to only worrying about the things that are under our control.”
For risk managers who find that the idea of community partnerships is a hard sell to the C-suite, Patton added that the benefits go beyond managing climate risk. Companies can approach their community’s climate risk issues much as they would any other public service project, she said. “Not something huge, not something that would go outside their economic model, but just a twist in the way that they’re interacting with their communities. It has all sorts of co-benefits that come with it … things like brand, value, advertising. It’s a way to rethink how they get their name out in the community” in a way which is moving toward resilience while delivering other benefits.
The nature of climate risk dictates that companies factor climate changes into corporate decision-making just the same way that companies might evaluate market conditions, tax implications, political instability or any other key exposure.
That long-range scope might not be the responsibility of risk management in some organizations.
“That looks a lot more like strategy,” said Marsh’s Smy. “That’s planning, more than managing day-to-day risk.”
Climate risk and resiliency, then, are the place where strategy and risk management are converging. Savvy business leaders will view decisions through the lens of resiliency in order to protect the organization’s interests.
Ultimately, said Smy, this can better position risk managers within an organization. “It creates an opportunity to address something that’s a strategic issue, at the board level, and I think that’s a great opportunity for risk managers to be thoughtful about it and not be kept in the box of insurance.”
“Resiliency is an opportunity for risk managers to elevate their place at the table,” said Andrew Thompson, global lead for catastrophe risk and insurance at Arup.
A true chief risk officer, said Zurich’s Patton, can act as an adviser to other parts of the organization, to help them think more broadly about the effects of climate risk on their decision-making process.
“The goal is to have people — as they’re thinking and planning — ask themselves, ‘Will this make us more or less resilient?’ ” said Max Young, communications director for 100 Resilient Cities, an initiative focused on building global resilience.
Corporate risk management has evolved into a sophisticated function in most corporations, said Petrilli. And now it is being further refined. “It has gone beyond insurance buying and into ERM,” he said.
“Resiliency is an opportunity for risk managers to elevate their place at the table.” — Andrew Thompson, global lead, catastrophe risk and insurance, Arup
“The board of directors needs to know not only what their operations are going to look like in the next year and the next cycle, but also that nothing is going to knock that off track.” And they also need to know that if an event does happen, there’s a well-thought-out plan in place that will maintain the company’s vitality. “That takes real strategic thinking,” he said.
Related R&I Coverage:
Global Program Premium Allocation: Why It Matters More Than You Think
Ten years after starting her medium-sized Greek yogurt manufacturing and distribution business in Chicago, Nancy is looking to open new facilities in Frankfurt, Germany and Seoul, South Korea. She has determined the company needs to have separate insurance policies for each location. Enter “premium allocation,” the process through which insurance premiums, fees and other charges are properly allocated among participants and geographies.
Experts say that the ideal premium allocation strategy is about balance. On one hand, it needs to appropriately reflect the risk being insured. On the other, it must satisfy the client’s objectives, as well as those of regulators, local subsidiaries, insurers and brokers., Ensuring that premium allocation is done appropriately and on a timely basis can make a multinational program run much smoother for everyone.
At first blush, premium allocation for a global insurance program is hardly buzzworthy. But as with our expanding hypothetical company, accurate, equitable premium allocation is a critical starting point. All parties have a vested interest in seeing that the allocation is done correctly and efficiently.
“This rather prosaic topic affects everyone … brokers, clients and carriers. Many risk managers with global experience understand how critical it is to get the premium allocation right. But for those new to foreign markets, they may not understand the intricacies of why it matters.”
– Marty Scherzer, President of Global Risk Solutions, AIG
Basic goals of key players include:
- Buyer – corporate office: Wants to ensure that the organization is adequately covered while engineering an optimal financial structure. The optimized structure is dependent on balancing local regulatory, tax and market conditions while providing for the appropriate premium to cover the risk.
- Buyer – local offices: Needs to have justification that the internal allocations of the premium expense fairly represent the local office’s risk exposure.
- Broker: The resources that are assigned to manage the program in a local country need to be appropriately compensated. Their compensation is often determined by the premium allocated to their country. A premium allocation that does not effectively correlate to the needs of the local office has the potential to under- or over-compensate these resources.
- Insurer: Needs to satisfy regulators that oversee the insurer’s local insurance operations that the premiums are fair, reasonable and commensurate with the risks being covered.
According to Marty Scherzer, President of Global Risk Solutions at AIG, as globalization continues to drive U.S. companies of varying sizes to expand their markets beyond domestic borders, premium allocation “needs to be done appropriately and timely; delay or get it wrong and it could prove costly.”
“This rather prosaic topic affects everyone … brokers, clients and carriers,” Scherzer says. “Many risk managers with global experience understand how critical it is to get the premium allocation right. But for those new to foreign markets, they may not understand the intricacies of why it matters.”
There are four critical challenges that need to be balanced if an allocation is to satisfy all parties, he says:
Across the globe, tax rates for insurance premiums vary widely. While a company will want to structure allocations to attain its financial objectives, the methodology employed needs to be reasonable and appropriate in the eyes of the carrier, broker, insured and regulator. Similarly, and in conjunction with tax and transfer pricing considerations, companies need to make sure that their premiums properly reflect the risk in each country. Even companies with the best intentions to allocate premiums appropriately are facing greater scrutiny. To properly address this issue, Scherzer recommends that companies maintain a well documented and justifiable rationale for their premium allocation in the event of a regulatory inquiry.
Insurance regulators worldwide seek to ensure that the carriers in their countries have both the capital and the ability to pay losses. Accordingly, they don’t want a premium being allocated to their country to be too low relative to the corresponding level of risk.
Without accurate data, premium allocation can be difficult, at best. Choosing to allocate premium based on sales in a given country or in a given time period, for example, can work. But if you don’t have that data for every subsidiary in a given country, the allocation will not be accurate. The key to appropriately allocating premium is to gather the required data well in advance of the program’s inception and scrub it for accuracy.
When creating an optimal multinational insurance program, premium allocation needs to be done quickly, but accurately. Without careful attention and planning, the process can easily become derailed.
Scherzer compares it to getting a little bit off course at the beginning of a long journey. A small deviation at the outset will have a magnified effect later on, landing you even farther away from your intended destination.
Figuring it all out
AIG has created the award-winning Multinational Program Design Tool to help companies decide whether (and where) to place local policies. The tool uses information that covers more than 200 countries, and provides results after answers to a few basic questions.
This interactive tool — iPad and PC-ready — requires just 10-15 minutes to complete in one of four languages (English, Spanish, Chinese and Japanese). The tool evaluates user feedback on exposures, geographies, risk sensitivities, preferences and needs against AIG’s knowledge of local regulatory, business and market factors and trends to produce a detailed report that can be used in the next level of discussion with brokers and AIG on a global insurance strategy, including premium allocation.
“The hope is that decision-makers partner with their broker and carrier to get premium allocation done early, accurately and right the first time,” Scherzer says.
For more information about AIG and its award-winning application, visit aig.com/multinational.