climate change and the real estate industry
TRANSCRIPT
STORMY WEATHER AHEAD?
CLIMATE CHANGE
AND THE REAL ESTATE INDUSTRY
Richard O. Faulk
Partner, Hollingsworth LLP
Washington, DC
Senior Director
Initiative for Energy and the Environment
Law & Economics Center, George Mason University School of Law
Arlington, Virginia
Climate Change Uncertainties • Climate Change is the ultimate “stress test” for those involved in real
estate.
• Even though many argue that the weight of scientific authority suggests serious risk, disagreements persist, especially in political circles.
• The risks are impacted by public policy makers, and their credibility, passion and relative success ultimately influences public perceptions and market response.
• Even today, decades into the climate change controversy, it appears that the worldwide population remains largely ignorant or indifferent to climate change – and the risks, however well-substantiated in the long run, are unquantifiable and unpredictable in the short term.
• Pricing of goods and services, such as financing and insurance, remains extremely difficult because of the lack of specific and quantifiable links between climate events and the existence and progression of global warming.
Climate Change Uncertainties
• There’s no guarantee that the progression of
climate change will be linear – or episodic.
• The rate, duration and reversibility of climate
change is not guaranteed – even if Earth’s
population adopts protective measures.
• It’s unclear whether humanity has the
resources and will to adopt and implement
preventive measures – even if it has the
capability to create them.
SOME OLD ADAGES
DON’T APPLY!
“Experience is the best tool for forecasting future risks.”
REALLY?
WHAT EXPERIENCE?
Climate change breaks prior molds -- lacks reliable precedents -- largely uses models
instead of actual observations -- and speaks in languages alien to public perception.
SOME OLD ADAGES DO!
“Location, Location, Location”
What about all the abandoned and recently constructed office and medical buildings on
“prime real estate” flooded by
Hurricane Katrina’s storm surge?
Memory is persistent regarding disasters – sometimes extraordinarily so. How long is
enough for recovery?
OTHER COMPLICATING FACTORS:
URBANIZATION
• Intergovernmental Panel on Climate Change (IPCC): “The
most important driver of increasing losses” for the insurance
industry is “concentrations of people and wealth in vulnerable
areas” and the increased penetration of insurance that
increased urban wealth enables.
• Urban areas are more vulnerable to disruptions in
transportation, electricity, clean water, sanitation, and flood
risks.
• Notwithstanding these risks, urban populations are increasing
– especially in the developing world, which often lacks
adequate protective infrastructure.
OTHER COMPLICATING FACTORS:
CATASROPHIC EVENTS
ULI’s 2014 Report: “Extreme Weather Events and Property”
• Found that the number of extreme storms and droughts doubled worldwide since the 1980s.
• Currently average averaging over 800 events per year.
• In the past ten years, decade, direct losses related to real estate and infrastructure have tripled, reaching US$150 billion annually.
• The ULI study concludes, “the occurrence of such events is therefore escalating and is likely to continue to do so.”
• When trends in urbanization and catastrophes are combined with other uncertainties, risks and the general inapplicability of traditional systems to cope and respond, reliable risk analysis and traditional risk management are threatened.
Particular Risk Categories
• Exposure to the physical risks of climate change (e.g., storms, flooding, crop losses)
• Material impacts to occupancy, production capacity, communications (e.g., disruption of utilities, internet access).
• Market factors (increased costs, dramatically increased or decreased demand for products and services, inability to receive or deliver essentials)
• Reputation and competitive risks
• Litigation and claims
Adaptation and Resilience
• In catastrophic situations, the magnitude of uninsured losses determines the community’s economic “resilience.”
• The higher the percentage of uninsured losses, the greater the likelihood that a natural disaster will have long-term negative economic consequences.
• Data from 1980 to 2011 show that for high-income, middle-income, and low-income countries, insurance covered 35 percent, 5 percent, and less than 1 percent, respectively, of direct losses from natural disasters. (IPCC)
• How can societies evaluate, project and protect themselves from underinsured losses?
AVAILABLE
RISK ASSESSMENT TOOLS • Modeling -- Developed to assist the insurance industry cope with
events that happen infrequently but which carry high risks when they occur. Modeling is useful but must be interpreted cautiously due to the lack of reliable long-term historical data.
• Scenario Analysis – “Stress tests” to study disaster scenarios. Generally changed yearly to include new data. Current scenarios include a combination of 8 hurricanes, windstorms, floods or typhoons; 4 earthquakes; and 2 terrorist events. For insurers, the goal is to ensure solvency after the “worst possible” 12 months (generally 1 in 200 (0.05%) chance.
• Risk Standards -- For insurers, the emerging goal is to ensure solvency after the “worst possible” 12 months (generally 1 in 200 (0.05%) chance. Standard is the current risk, not the “historic” risk. Others propose “stress test” for resilience to extreme natural disasters, that requires businesses to calculate the maximum probable annual loss for an extreme disaster scenario having a 1 in 100 (1 percent) annual risk.
AVAILABLE
RISK MANAGEMENT TOOLS • Parametric Insurance – multi-purpose disaster insurance. (designed to
compensate insured for disaster impacts. Used by governments (e.g.,
Haiti, State of Alabama) re earthquakes and other disasters.
• Parametric insurance applications have proved to be effective risk transfer
alternatives for certain risks in developing countries. They offer flexibility
both in terms of scope of risks and potential outreach for these countries.
• The international reinsurance community has provided valuable support
during the initial stages of the market development initiatives and has
expressed readiness to continue its support within the context of a broader
market development effort.
• More efforts need to be focused on developing sustainable and scalable
local markets. Parametric insurance applications are potentially an
attractive new line of business for local insurance companies, which
however often require the help of experienced commercial institutions.
DOES ANYONE FEEL SECURE?
• Despite millions of dollars and hours of research, and growing confidence within the insurance industry, substantial vulnerabilities and “data gaps” persist.
• Those who seek security will still have to pay significantly more for it – and still receive less than they want (or need).
• To control risks, businesses must incorporate risk analysis, risk management and protective strategies deeply into their own operations.
• These measures should address property acquisitions, site preparations, building design, construction options, energy and communications security, and other concerns.
• Even with diligent efforts to control risks, uncertainties persist, planning is difficult, and calculating comparative cost benefits is difficult. Yet personal engagement by responsible management is essential to ensure all issues and concerns are addressed.
CONCLUSIONS
• CAN THE RISKS BE TRULY IDENTIFIED AND EVALUATED?
• CAN THE EXTENT OF POTENTIAL LIABILITY BE REASONABLY ASSESSED?
• CAN THE COSTS OF COVERAGE BE ACCURATELY AND REASONABLY PRICED?
• CAN THE PARTICIPATION OF POTENTAL VICTIMS BE REASONABLY GUARANTEED, EITHER INDIVIDUALLY OR VIA GOVERNMEN T MANDATES?
• WILL THOSE WHO NEED COVERAGE HAVE THE RESOURCES TO OBTAIN IT?
• ARE GOVERNMENTS WILLING AND ABLE TO SUBSIDIZE COVERAGE FOR THOSE UNABLE TO AFFORD IT?
BE CAREFUL OUT THERE!
QUESTIONS?
Richard O. Faulk
Partner, Hollingsworth LLP
Washington, DC
(202) 898-5813
Senior Director, Energy and the Environment
Law & Economics Center
George Mason University School of Law
Arlington, VA
(713) 408-7023