By John Hintze
Companies are thinking more about how weather is affecting their business.
Walmart can calculate to the dollar how much a degree change in temperature costs the giant retailer, but the impact of storms erupting across the US during the company’s first quarter was something new, said William Simon, president and CEO of Walmart, in a May 15 earnings-related call with the media.
“What’s really interesting and unusual about [the first] quarter was the supply chain interruption,” Mr. Simon said.
He added that the sequencing and duration of storms as they tracked across the country actually impacted manufacturing, slowing production and backing up fleet transportation. Walmart then had to pay its own trucking fleet overtime and engage third-party trucking once the storms cleared to resupply its stores. “So for the first time that I can recall, the entire supply chain in the US got backed up for a period and we [needed] to spend money to expedite that,” Mr. Simon said.
The $0.03 per share impact from what Walmart described as “severe weather” wasn’t a major dent, but without it the retailer would have nearly matched last year’s first quarter earnings per share from continuing operations. And the growing consensus is that such weather as well as hurricanes and other catastrophic storms are only going to increase in severity as the climate changes.
That risk is currently not accounted for in public companies’ financial statements. However, an initiative to change that, until now flying largely under the radar screen, is anticipated to find the spotlight in September at the UN Climate Action Day. It will be the first of a string of high-profile events aimed at building awareness of the risk, with one of the goals to institute requirements for companies to disclose not only its impact in monetary terms but their mitigation efforts.
Walmart is one of 14 multinationals that are part of an initiative, comprising organizations in the public and private sectors and led by the UN Office for Disaster Risk Reduction (UNISDOR), to raise global awareness of natural hazards and risk resilience. Other corporate participants include General Electric, HCC Group, HIRCO Group, Hitachi Group, InterContinental Hotels Group, Nestlé, NTT East Corporation and Roche.
The UN’s Plan
The UN Millennium & Sustainable Goals initiative, which includes environmental sustainability, will be updated in the summer, followed by the UN Climate Change Conference in December, and the World Humanitarian Summit in 2016. But the rules could come sooner rather than later.
In terms of disaster-related disclosures for companies, Rowan Douglas, chairman of the Willis Research Network, said, “People are talking about 2020 for these new rules to be applied in financial regulation and accounting.”
That isn’t far away. Realizing this, major institutional investors, such as Franklin Templeton and the California Public Employees’ Retirement System, have already started to incorporate natural disaster risk into their investment analysis. Financial disclosures would provide greater transparency into not only the risk corporates face but also their mitigation efforts, which could include locating facilities in areas less prone to extreme weather events as well as insurance and insurance-linked securities, such as catastrophe bonds.
Thinking disasters
Rowan Douglas, chairman of the Willis Research Network, a part of multinational insurance and reinsurance advisor and broker Willis Group, published a paper in June that describes the initiative as well as what disaster-related disclosures could look like. Titled “Integrating Natural Disaster Risks & Resilience into the Financial System,” the paper notes that, “Integrating disaster risk and resilience into the financial system provides the structural and proportionate means of saving millions of lives and livelihoods in the coming decades and protecting US$ billions in homes, assets and property in a cost effective and rational way…”
Mr. Douglas said in an interview that the insurance sector’s near-existential crisis in the late 1980s and early 1990s, driven largely by natural disasters, prompted the industry to decide that insurance contracts should be able to cover extreme weather events potentially occurring only once every 200 years. It took time for insurers to incorporate the new approach and adjust their capital appropriately. But when three hurricanes hit US shores in 2005, including Katrina, insurance and reinsurance companies were able to handle claims with few insolvencies, and the same held true for Superstorm Sandy in 2012. “So the feeling is these are the basic lessons that we’ve learned in the insurance and reinsurance industries and they should be applied more broadly,” Mr. Douglas said.
Insurance underwriting represents a small portion of the financial industry. Yet the much larger sectors of investments and securities, credit and debt, and taxation, accounting and reporting simply do not take adequate account of disaster risk, Mr. Douglas said. He proposes three metrics to measure such risk that could be translated into key ratios and used by investors, lenders and other relevant parties.
One is a company’s maximum probable annual losses stemming from natural disasters compared to its current assets and operations that occurs in one out of every 100 years, a test indicating a company’s solvency in an extreme natural disaster scenario. A similar calculation, but for one 20 years out, would gauge profit risk in a given year, and an annual average loss calculation would describe and compare the economic disaster risk exposure across companies.
All three measures are currently used by the insurance industry and well understood, Mr. Douglas said, and many companies already collect this information to comply with existing insurance policies.
Such disclosures will be introduced in a series of events that should catalyze efforts to incorporate them in financial statements. The Climate Action Day event in New York is setting the stage for renewal of the UN’s Hyogo Framework for Action on Disaster Risk Reduction, the first internationally accepted framework, signed a decade ago by UN members, to formally set out goals to reduce natural disaster risk.
“Because it focuses on disaster risk and resilience, rather than areas like climate change, which is related but different, this area has gained potential for significant traction,” Mr. Douglas said.