Risk management: Corporations talk green but do little on climate

It’s easy to talk about how hotel companies with coastal property might have to face more hurricanes or rising sea levels. But it’s quite hard to know what is going to happen to any given beachfront resort with a sufficiently high degree of certainty. Given the enormous amount of variability in any complex model, if a company spent a lot of money carefully mitigating the risk of X, it could end up getting blindsided by Y instead.

“There are very difficult models to develop, with more rain here, less rain there,” says Andy Hoffman, associate director of the Erb Institute for Global Sustainable Enterprise at the University of Michigan.

Finally, even if the effects of climate change are foreseeable, they can be impossible to hedge.

Say you’re an electronics manufacturer who is pretty sure that climate change is going to wallop Bolivia, resulting in political unrest and a spike in the price of lithium. All your devices run on lithium batteries, so this is a serious risk, but it’s far from obvious what you can do about it. It’s silly to start stockpiling lithium, and you can’t even bet on rising lithium prices 10 years from now, since it’s not a metal that is heavily traded in the futures markets. Essentially all that you can do is be very clear about the risk in your SEC filings and go about your business as normal. And identifying a risk is not the same thing as being able to negate it.

A classic business hedging strategy is to buy insurance. Reinsurance companies have expensive and sophisticated climate-change models. Pricing such risk is what they do. In many cases, they will make more money as the effects of climate change become increasingly visible and expensive, since they’ll simply raise premiums on everybody while refusing to insure the most vulnerable at any price.

But insurance doesn’t work very well as an adaptation strategy. Policies last for only one year, or at most two. The insurance companies don’t need to charge higher rates now if they see big and nasty things happening to the global climate in 20 years’ time—they can continue more or less as they are for the time being. It’s easy to forget that if you’re simply renewing an insurance policy every year: the existence of the insurance market gives companies a sense of false security that their risks are hedged.

To put it another way, insurance is a highly imperfect hedge for climate change, because it can go away or rise in cost very suddenly. After the Bhopal disaster in 1984, pollution-liability insurance first disappeared entirely and then, when it came back, cost 10 times as much. The risk of rising insurance costs—or insurance becoming impossible to buy at any price—is something so inherently difficult to protect against, most companies don’t even bother trying.

The behavioral economist Dan Ariely, author of Predictably Irrational, likes to say that climate change is a problem that is perfectly designed to make people do nothing: It happens far in the future; its effects will be felt most greatly by other people; and the efforts of any one individual are minuscule.

Companies, too, tend to behave in predictably irrational ways. Executives should try to imagine their companies 30 years down the line, struggling with the deleterious effects of climate change on profitability and corporate survival. But they don’t. That’s a job for the next CEO’s successor’s successor. Right now there are a million other things that seem much more urgent, starting with this quarter’s earnings.

This story was produced for Slate for the Climate Desk collaboration.

 
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