Last month, a major new report on climate risk by insurance broker Willis Towers Watson called for tougher stress testing, among other measures, in order to tackle what it called the growing global climate resilience gap.
The Willis Towers Watson Real Estate Climate Risk Report brought together companies including British Land, Land Securities, Lendlease, NatWest and the John Lewis Partnership to examine how the real estate industry is approaching climate risk in the wake of the Paris Agreement.
Property Week caught up with Dr Torolf Hamm, partner in Willis Towers Watson’s strategic risk consulting team, and Edward Brown, director of the real estate practice, to find out more.
Dr Torolf Hamm (TH): I work in the field of natural disaster risk management. In that context I work with a lot of corporate clients. What we tried to do was better understand and quantify the risks for our client base. We’re trying to prepare clients for a more uncertain future and a potential step-change when it comes to climate variability. In that context we are looking at different time horizons as well.
TH: Often what we find is that clients don’t really have a good view on what their exposures are now. What they have to do is identify the exposures, quantify them and then find ways to mitigate them. They have to adapt to the risks. It’s trying to tailor a pragmatic approach that can then be used to optimise their risk financing strategy.
TH: In terms of data, the first question is understanding what you’re exposed to. So you have to understand where your locations are.
Flood hazard, for instance, is extremely localised and if you don’t know where you are then whatever you do in terms of trying to quantify risk will be very uncertain. Then you need to understand your exposure in monetary terms, so what your exposures are in terms of property damage, business interruption and loss of rent. You need all those things to fully understand catastrophe risk. We needed to work with clients on the data to provide useful results.
TH: It depends. Some clients are quite sophisticated and have good measures in place to collect the data. But what often happens is that clients are prepared to some degree but really only wake up when something happens.
When a big flood happens in the UK, for instance, we get a lot of enquiries coming in simply because clients get a shock and hadn’t realised that they had that level of exposure. We’ve had quite a lot of severe and low-probability events recently, such as the 2015-16 winter flood. People then get shocked and say ‘Gosh, this has happened to me now.’ We’ve got to make clients aware of these events and the probability that they will be happening more often in the future. It’s a human trait - often people avoid thinking about the unexpected. We’re trying to help clients to think along those lines and be sensitive to what they can do to quantify the risks. So in some instances they are prepared, but for many it simply isn’t on their radar.
Edward Brown (EB): Investment strategies are absolutely going to be driven by this. Just last week I had a client who wanted to invest along the banks of the Seine in Paris who called me and asked what chance he had of getting flood insurance. As it happens it is still available, maybe more costly than it was before the Seine flooded, but they’re starting to really think about these sorts of issues when they’re thinking about buying properties.
EB: A lot of our clients are thinking about how they can reshape portfolios or how they can mitigate losses for properties that they want to keep. The other element is if an area becomes a hotspot for a particular issue, whether that’s flooding or something else, then it’s going to drive down the values of properties locally. Therefore people are going to invest in some areas and not in others and the value of portfolios could considerably devalue.
TH: That’s correct. What happens if you do a catastrophe risk quantification study is first of all we look at the risk from a portfolio basis. So you’re looking at the whole portfolio and trying to identify and quantify the risk on an aggregated level, which is telling you a little more around whether you are adequately covered. What you can also do is look at the locations and the assets that are contributing most to overall portfolio losses. So you can look at perhaps the top 10 locations that are contributing to the modelled loss and focus on those sites, screening the data to really reduce risk.
Once you have the shortlist of locations, you can do site surveys and understand the location at a really granular level. You can look at what mitigation has already been put in place and whether a building has been built with a hazard in mind.
TH: We looked at some buildings in Austria and in areas where flooding happens regularly. What you see is that people are starting to live with the hazard and are actually adapting. They are using building materials that are less prone to flood damage so they can get up and running again more quickly. They’re putting key equipment in better places, so not putting it in basements or at ground level. So once you have a shortlist of locations that are driving the overall portfolio risk you can really start to mitigate the worst of the risk.
TH: People often tell us that they understand ‘the now’ but ask what climate change means for their risks. Obviously it has been recognised as an issue globally, but what does it mean from a corporate client’s perspective on a more granular level? And what does it mean for different time horizons?
So if you’re talking about the next five years, maybe the changes you might be expecting are so small that they’re not really measurable. But if you go into the more medium term - so the next decade and beyond - you might see more extreme events. And if you go further, so several decades from now, there could be a real step-change. There is so much uncertainty around the subject, but at the very least you want to stress-test these scenarios. That’s what we’re trying to do: come up with pragmatic solutions.
EB: Cover is available now in the real estate sector for all risks. It may be limited and subject to vastly increased premiums, but it is still available. The other aspect is that a lot of buildings are subject to lenders’ finance agreements and so on. The cover is available now so that ticks the box so far as the lender is concerned, but a few years down the line is the borrower going to be in breach of the agreement by virtue of not being able to get or afford the right cover?