Climate change is costly. NOAA has been tracking the economic impacts of extreme weather events in the US since 1980. In a recent study, the agency reported an increase in both the number of severe storms in recent years, as well as the overall financial and economic impacts associated with each (graphic below taken from this work). In the past 40 years, there has been 1.825 trillion dollars worth of damage from extreme weather events.
At the same time, the ASCE predicted a $3.9 trillion gap in infrastructure needs by as early as 2025 – and this does not take account climate change impacts . The IPCC has made its own sobering projections, warning that an increase of 1.5 C of warming could lead to $54 trillion in damages from climate change alone – and occur as early as 2040. A 2.0°C increase is expected to result in $69 trillion impact, whereas a 3.7°C would cause $551 trillion in damage. To put these numbers into perspective, the global GDP for 2019 has been measured at approximately $133 trillion.
Where do these costs show up in the financials?
Based on this, we would assume to see these costs starting to impact fiscal health indicators – in both the public and the private sectors. However, this is not the case – for several reasons. The first being that risk is often assessed on an annual basis and then reset. This is particularly true for insurance underwriting and even credit rating assessments. A yearly assessment of risk is not appropriate for longer-lived assets such as infrastructure, buildings or even communities. If we take the 1% (1 in 100 year event) and look at the cumulative risk over 30 years, there is actually a 26% chance that an asset will be impacted during that time. If you extend that to a 50 year window, there is 39% chance that the asset will be impacted.
However, the market has chosen to reset that risk on an annual basis. This leads to the actual risk (over the life expectancy of that asset) to be greatly underestimated which, in turn, undercuts the value of resilience (avoided risk) and therefore creates a significant challenge in making the business case for resilience.
Another reason that we are failing to see these costs reflected in traditional financial reports is because of how and when the data are being collected and reported. As a case in point, I recently published on original research (completed in collaboration with Bruce MacDonald from the North Carolina State University and Craig Maher from the University of Nebraska, Omaha – see Business Case Blog #2) where we looked at the annual indicators of public fiscal health in cities that had recently experienced some of the extreme NOAA events described above. Our instincts were that these types of events had to be leaving a financial fingerprint that could be tracked through existing yearly reporting.
As it turned out, that was not the case – and there were even some cases where the inverse seemed true. In some cities that experienced severe events, the actual fiscal health measures improved. This was due to the influx of external funding (such as federal disaster funding, state grants, insured losses, etc.) which exceeded their original revenue projections. What is not being adequately captured or reported are the actual losses incurred because of that event – and how that compared to the budgeted expenses for that year versus actual expenses BEFORE any additional funding was received. These are the sorts of metrics that are essential in order to quantify the true COST of climate risk so that we can effectively capture the VALUE of resilience.
Example of the types of post-disaster costs that are incurred but very rarely anticipated in yearly budgets.
The summary of this work is part of a larger report that ULI and Heitman funded: Climate Risk and Real Estate: emerging practices for Market Assessment.
Moving Forward
The intent of this blog is to share the latest thinking around climate change costs, how valuation is currently calculated in financial and economic markets, as well as how it should be calculated with respect to climate change. We will highlight alternative funding and financing models that would lend themselves to both local and large-scale investments in resilience, and case studies where these approaches have already been used.
This is an evolving field and will require a shift in how we assess, underwrite and value risk and resilience. It will also require that each side – the public sector (especially communities and asset owners) and the private sector (including investors, underwriters and asset managers) create a common valuation system with respect to resilience. There are already willing partners on each side. The goal of Climate Advisory is to facilitate those connections in order to incentivize large-scale investment in climate resilience.
