Managing Asia's climate risks
How are business leaders integrating climate risks into their decisions?
Introduction
In 2022, natural disasters cost Asia around US$70 billion. Of that number, only around US$10 billion was insured, according to data from reinsurance company Munich Re.
Developing countries in the region are disproportionately affected by physical climate risks. Between 2000 and 2019, the Climate Risk Index ranked Myanmar, the Philippines, Bangladesh, Pakistan, Thailand, and Nepal among the top 10 countries most affected by extreme weather events.
Despite increasing consensus that developing countries should receive more support from wealthier nations – as seen from the landmark deal to establish a “loss and damage” fund to help vulnerable nations recover from climate disasters following last year’s COP27 climate conference – the losses these economies face from natural disasters remain almost completely uninsured.
Asia’s vulnerability to climate risks extends beyond physical risks. A 2022 McKinsey analysis showed that on average, about 37 per cent of the region’s gross domestic product (GDP) stems from sectors most exposed to the net-zero transition, which is slightly above the world average of around 35 per cent. Within the region, less developed countries, those with larger fossil fuel resources, and manufacturing-dependent economies are most likely to suffer the most.
Mounting regulations in Asia mandating disclosures on climate-related risks in line with guidelines add to the growing pressure on business leaders in the region to factor climate risks into their decisions. This includes the Task Force on Climate-related Financial Disclosures (TCFD), which is an international initiative that provides a framework for companies to disclose information on their climate-related risks and opportunities to investors.
How can Asian businesses with varying levels of exposure to climate risks better manage and price in these risks? As society’s risk manager, how is the insurance industry partnering with businesses and governments to build Asia’s climate resilience?
This report – compiled through research and engagement with experts in climate risks, finance, and insurance – provides insights into how businesses and investors in Asia are integrating climate risks into their decisions, as well as the evolving role of the insurance sector in managing climate-related uncertainties within the region.
A new era for Asia
While Europe remains in the lead for climate-related financial disclosures, Asia Pacific recorded the second-highest level of disclosures in the 2022 TCFD status report.
“Reporting against TCFD is the first key step for your company. It’s something that investors are increasingly looking for, because it provides them with the data and analysis that companies do around climate risk,” says Aurélia Britsch, global head of climate risk, Sustainable Fitch, which is the ESG arm of the credit rating agency Fitch Ratings.
In financial year 2021, 36 per cent of Asian companies made disclosures across all 11 recommendations in the TCFD framework, including on risk management. Compared to 2019, this was a marked improvement of 11 percentage points.
The number of climate-related disclosures is set to increase, given that at least seven Asian jurisdictions have issued guidance incorporating TCFD recommendations since 2021.
Blue-chip Japanese companies listed on the Tokyo Stock Exchange’s “prime” market are required to comply with its TCFD-aligned rules from April 2022. Singapore made climate reporting mandatory for financial institutions from financial year 2023, while Hong Kong plans to make it mandatory for all listed companies by 2025.
Figure 1: More companies are disclosing climate risks in compliance with the 11 recommendations by the Task Force on Climate-related Financial Disclosures, with Europe in the lead. Infographic: Eco-Business/Philip Amiote
Figure 1: More companies are disclosing climate risks in compliance with the 11 recommendations by the Task Force on Climate-related Financial Disclosures, with Europe in the lead. Infographic: Eco-Business/Philip Amiote
Figure 2: The progress companies have made in implementing TCFD recommendations over the past five years. Infographic: Eco-Business/Philip Amiote
Figure 2: The progress companies have made in implementing TCFD recommendations over the past five years. Infographic: Eco-Business/Philip Amiote
Investors are also increasingly pressuring entities they have invested money in to outline their physical risks, and how they plan on adapting to or mitigating them.
For instance, investor group Asia Investor Group on Climate Change (AIGCC) – which includes Singapore’s sovereign wealth fund GIC – coordinates the Asian Utilities Engagement Programme, which works with public policymakers and other stakeholders to cut the carbon footprint of identified utilities in Asia. The programme currently includes five utility companies from China, Hong Kong, Japan, Indonesia, and Malaysia.
Despite many ongoing discussions, climate risk is still not formally factored into financial markets, be it in equities, fixed income, or real estate, notes Britsch. Fitch Ratings only formally integrated climate risks into its credit assessment in 2019 through ESG Relevance Scores, which indicates the relevant ESG risks to each entity’s credit rating decision.
“Before that, those ESG-related risks were informally integrated into the credit rating assessment. But now it is being formalised and done on a more systematic basis. Fitch Ratings is also separating climate risk from general ESG risks,” Britsch adds.
As a result, it will be crucial for Asian businesses to factor in transition risks, like increasing regulations and investor pressure, alongside physical climate risks. Environmental legislation around major exports, such as the European Union’s proposed tariffs on carbon-intensive imports like steel and cement from the region, will also add to the costs that Asian companies will face in the transition.
“Reporting against TCFD is the first key step for your company. It’s something that investors are increasingly looking for because it provides them with the data and analysis that companies do around climate risk."
Ways to factor in climate risks
The TCFD provides guidance on how companies, governments, and cities should disclose climate-related risks, and divides these risks into two major categories. The first involves transition risks, or any risks associated with the transition to a lower-carbon economy. The second being physical risks, which are risks related to the physical impacts of climate change.
Transition risks from emerging regulations and heightened client expectations are directly affecting the assumptions incorporated in the valuations of investments, observes Monica Bae, AIGCC’s director for investor practice. She notes that the increase in physical risks affects investment assets, which can then impact an investor's risk-return profile.
“Although the amount of risk-adjusted returns still differs from market to market and investor to investor, the general impact is undeniable,” says Bae.
Physical risks can be event-driven, such as when floods or typhoons disrupt businesses and damage properties, resulting in lower asset values and higher risks for insurance underwriters. They can also stem from longer-term shifts in climate patterns, like rising temperatures, precipitation and sea levels, leading to less productive land and labour.
“For example, in Singapore, what is heat stress doing to worker productivity?” asks Christopher Au, director of Climate and Resilience Hub, Asia Pacific, WTW, a global insurance broker. “If you’re working on a construction site and the temperatures suddenly rise to a certain level, what does that do to the speed of construction? That’s a chronic physical risk, in addition to acute events.”
These intensified physical risks could manifest in “any fixed location that is producing high value outputs where business interruption becomes an issue quite quickly,” adds Au. The leisure, hospitality, retail, and manufacturing sectors also have “reasonable exposure” to such risks, in addition to the construction and real estate sectors.
Companies can better understand how climate-related risks may impact their business through scenario analyses to make more informed decisions, which involves exploring different plausible future scenarios that challenge business-as-usual assumptions.
However, scenario analysis remains an important gap in climate-related reporting. Disclosures on how resilient company strategies are under different climate-related scenarios continues to be the lowest among the 11 recommended TCFD disclosures at 16 per cent, according to the 2022 TCFD status report. Companies surveyed found it challenging to select relevant scenarios and identify key inputs and parameters.
The financial sector
AIGCC’s survey of Asian investors in 2022 found that more than half of the respondents have not undertaken climate-related physical risk assessments, while only 6 per cent have implemented such an analysis and believe that their portfolio is resilient.
According to UNEP FI’s 2019 report, financial institutions have a wide array of service providers that support TCFD-compliant scenario analysis to choose from, depending on their desired scope, depth, and focus of analysis.
UNEP FI launched a transition risk exposure heat map in 2020, offering a framework for corporate lenders and other financial institutions to quantify how climate-sensitive sectors may be impacted by a low-carbon transition.
Institutional investors may also refer to the Inevitable Policy Response (IPR), which was commissioned by the UN Principles for Responsible Investment in 2018, to navigate the evolving policy and regulatory landscape. The consortium – which counts financial institutions like BlackRock, Fitch Ratings, and Goldman Sachs among its strategic partners – develops climate scenarios that forecast accelerated policy responses to climate change.
Fitch Ratings introduced its Climate Vulnerability Scores in 2021 for the utilities, oil and gas, and chemicals sectors based on the IPR scenarios to measure the vulnerability of corporate entities or sectors to climate risks under various scenarios at a particular point of time. It was extended in 2022 to all corporate sectors.
Such a scenario-based analysis of credit ratings will allow transition risks to be “priced in eventually into fixed income markets,” says Britsch.
Image: John Marvin De Jose via Unsplash
Image: John Marvin De Jose via Unsplash
Non-financial sectors
While most analysis tools are still primarily targeted at the financial sector, they can be adapted for other sectors as well.
TCFD’s guidance on scenario analysis for non-financial companies recommends using publicly available scenarios, such as those provided by the Intergovernmental Panel on Climate Change (IPCC) and International Energy Agency (IEA), as starting points, which can be further customised by companies in-house as their understanding of climate-related risks increases over time.
For instance, IPCC’s Representative Concentration Pathways (RCPs) serve as building blocks for scenarios modelled on physical risks; they represent different measures of atmospheric greenhouse gas concentration trajectories for the long-term future. Meanwhile, IEA Scenarios focus on transition risks. They include the Stated Policies Scenario, Delayed Response Scenario, Sustainable Response Scenario, and Net Zero Emissions by 2050, all of which are published in their annual flagship report, the World Energy Outlook.
Figure 3: Publicly available climate scenario tools for the financial and the non-financial sectors. Infographic: Eco-Business/Philip Amiote
Figure 3: Publicly available climate scenario tools for the financial and the non-financial sectors. Infographic: Eco-Business/Philip Amiote
Closing the climate protection gap
Asia’s heavy reliance on agriculture for livelihoods makes it one of the most vulnerable sectors to physical climate risks in the region. IPCC’s sixth assessment report warns that increasing temperatures, changing precipitation levels, and extreme weather events will escalate agriculture risks in South, Southeast, and Central Asia. This may widen the climate protection gap, or the difference between total economic losses and insured losses after a climate-related catastrophe.
“Agriculture is not particularly well dealt with. There’s a large protection gap between the economic loss of an event and what is financially protected. This is possibly because you’re talking about a rural environment that doesn’t necessarily have the infrastructure conventionally used for banking and financial services,” Au suggests.
"Silent" climate risks may lead individual farming households in Southeast Asia to take fewer loans to improve their inputs and yields, causing them to operate below their capabilities to avoid defaulting on loans. This can be economically unproductive, Au says, as these smallholder farmers are avoiding taking on business loans, which are typically necessary for small businesses to ease cash flow issues or to expand operations.
This “hidden risk” in agriculture that Au notes was what United Nations-backed De-risk Southeast Asia project sought to address by developing climate risk management systems. These included index-based insurance products to protect smallholder farmers and businesses engaged in producing crops like coffee, sugar, rice, and cassava in key Southeast Asian countries from climate-induced impacts.
“Agriculture is not particularly well dealt with. There’s a large protection gap between the economic loss of an event and what is financially protected. This is possibly because you’re talking about a rural environment that doesn’t necessarily have the infrastructure conventionally used for banking and financial services."
Resting insured
Index-based insurance products, also called parametric insurance products, allow benefits to be paid out automatically when certain predetermined weather conditions, such as rainfall or livestock mortality rates, are met. This eliminates the need for traditional claims assessments, making the settlement process simpler, quicker, and more affordable.
“You can break climate risk down into what you can manage and adapt to, like improving irrigation and crop varieties. But you’ll reach a point where it becomes too expensive to adapt, and then you have this leftover risk. This is where the insurance comes in,” says Jarrod Kath, a senior lecturer in ecology and conservation at the University of Southern Queensland, who was also involved in De-risk Southeast Asia.
While farmers may adapt certain crops to the changing climate using readily available technology to avoid leftover risk, insurance may be required for long-term crops like coffee, where it could get “exceedingly expensive” to plant new varieties, Kath explains.
Beyond agriculture, such innovative insurance products can also be used to alleviate losses faced by tourism-dependent sectors during natural disasters.
“If a typhoon comes into a city in Vietnam, they could get a payout, under the assumption that there is interruption at the airport, less tourists, and low hotel occupancy rates,” expounds Au. “Once you start unpacking what parametric insurance can do, you expand the role of insurance.”
Au cites a project WTW developed in collaboration with World Wildlife Foundation where insurance is being used as a form of social safety net. The project allows vulnerable fishing communities in Fiji and Papua New Guinea to receive payouts much faster following an adverse weather event. “They would probably receive something from the government in time, but parametric insurance allows us to pay out within a week,” says Au.
In 2021, WTW also collaborated with the Mesoamerican Reef Fund to launch the world’s first insurance protection for the endangered reef system along the Caribbean coast. The Asian Development Bank (ADB) has since supported a similar multi-million-dollar project, financed by the Asia Pacific Climate Finance Fund and the Global Environment Facility, to develop coral reef financing and insurance models to protect these ecosystems in Fiji, Indonesia, the Philippines, and Solomon Islands.
Asia is home to the Coral Triangle, which stretches across six countries in Southeast Asia and the Pacific. The area contains 76 per cent of all known coral species and 37 per cent of the total coral reef fish species in the world, making it one of the planet’s richest centres of marine life. Forty-two per cent of the world’s mangroves are also found in the region.
However, over the past three decades, more than 50 per cent of the world’s reefs have disappeared and over 75 per cent have been damaged as a result of climate change. The ASEAN region has also lost about a third of its mangrove forests in the past 40 years, according to the ASEAN Centre for Biodiversity.
Research has shown that mangrove and reef ecosystems can reduce water levels and wave energy by slowing the flow of water and reducing surface waves during a storm surge. The insurance sector can support and scale conservation efforts by quantifying the benefits of protecting these ecosystems for businesses through risk modelling, says Au. For instance, an individual who owns a factory near the shoreline may now have an interest in having strong and healthy mangroves nearby, as they act as a natural barrier and reduce the force of incoming waves. This, in turn, may protect the factory from potential floods or storm surges, he notes.
As of 2021, 83 per cent of economic losses in Asia are not adequately covered by insurance, surpassing the world average of 56 per cent.
Since insurance is all about the transfer of risks, if climate-related risks continue to increase, so will the premiums, which could lead companies to buy less insurance and transfer less of their risks, says Au, noting that insurance companies are starting to engage businesses and organisations a lot earlier to mitigate risks before they occur.
Bracing for the future
Adopting tools from insurers
Using extensive data and advanced risk analysis tools, insurance companies can now identify areas vulnerable to climate change and then work with policymakers and businesses to develop risk management strategies before losses occur.
This has led a slew of insurers, such as Aon, Chubb, Munich Re, and WTW, to promote their risk engineering services to banks and other sectors.
“The insurance industry prices risk. For example, a flood that maybe happens once every 80 years can be turned into a financial number. Insurance analytics are increasingly being used to direct investment. The big banks are also starting to use insurance modeling tools to understand the risk-return of an investment they make,” says Au.
Before investing in a factory, or any other fixed assets, banks can work with risk engineers or use risk assessment tools to evaluate potential climate-induced property damage and business interruptions, explains Au.
The evolving role of the insurance sector
Despite being tasked with managing society’s risks, climate risks also threaten the insurance sector. As the former chairman and CEO of AXA Group put in 2015, “We know that if average temperatures increased by two-degrees Celsius, the world may still be insurable. But it's very clear that at four-degree Celsius it would not.”
The sector must evolve to intervene earlier, especially in Asia, to continue playing a key role amid a warming climate.
“We have a very strong view that insurance can incentivise transition planning. We developed an industry standard called Climate Transition Pathways, which is a standard for power plants across the world, with a very clear focus on Asia. If power plants develop a transition plan that is Paris-aligned, they will have access to insurance capacity that has been pre-committed by insurers for this purpose,” says Au, who dismissed the idea of excluding the provision of coverage to certain sectors like coal.
“We're focused on the reduction of carbon emissions across the system as it’s not about an individual entity,” he adds. Rather than getting “too concerned” with carbon accounting, Au argues that companies should consider what products and services need to exist in a low-carbon economy and develop a plan to work towards materialising them.
Kath has recently been researching natural capital, which is the idea of valuing nature beyond the raw materials it provides as a means of production to include the role of the environment and ecosystems in supporting human well-being.
He points at that while “green” or “adaptation” solutions – such as planting more trees to sequester carbon, revegetate an area for biodiversity, or to provide shade for crops – may serve to reduce climate risks, these same solutions are not immune to climate change.
As decarbonisation efforts ramp up in scale and speed, they present a so-called “risk-risk” trade-off, where measures to mitigate climate risk unintentionally become a source of additional risks, going beyond the traditional risk-return matrix.
Adopting a systems perspective
Enabling the low-carbon transition and mitigating climate risks requires individual businesses, sectors, and jurisdictions to work together and consider a broad spectrum of metrics, instead of focusing squarely on a single metric like carbon emissions.
It will require a systems perspective that embraces the complexity of the transition and minimises disruption to the most vulnerable communities in the region. Policies, such as the mandating of TCFD-aligned disclosures and public-private partnerships like ADB’s Energy Transition Mechanism, or the De-risk Southeast Asia project, mark the beginning of system-wide changes that need to take place in Asia. Businesses in the region must adopt the latest scientific insights, risk assessment methodologies, and climate risk management tools.
One such tool currently under development is the Social Cost of Carbon (SCC), which is a comprehensive estimate of all the damage from carbon emissions, ranging from lost crops to the deterioration of human health, and can be used by policymakers to weigh the benefits of policies to tackle climate change against their costs. For example, if the benefits of a policy to prevent further emissions outweigh the SCC, the policy pays for itself in the long run, even if household and business expenses increase in the short term.
Currently, the federal governments of the US and Canada use the SCC – estimated to be US$51 under the Biden administration – when considering regulatory proposals. However, current estimates of the SCC have been contested, with the US Environmental Protection Agency proposing to raise it by nearly fourfold to US$190 and prominent economists Joseph Stiglitz and Nicholas Stern suggesting an alternative measure called a “target-consistent approach” to SCC.
Under this target-consistent approach, a target – say the Paris Agreement goal to limit global warming to well below two-degrees Celsius – is taken and the costs associated with reducing emissions are estimated, which can then be used to calculate the most affordable pathway to meet this target across the world.
“Asia is uniquely positioned in the global economy – it has some of the world’s most developed markets and many emerging markets, and it is a melting pot of different cultures and social diversity,” Bae says.
"Considering Asia’s complexities and different market nuances, if we are able to address climate change and align investments to the Paris Agreement, the possibility of reaching 1.5-degrees Celsius with no or limited overshoot would substantially rise.”
Credits
Eco-Business wishes to credit the following people who contributed to the development of this report:
Aurélia Britsch, Christopher Au, Jarrod Kath, and Monica Bae.
This report was developed and written by Gabrielle See, with the support of Jeremy Chan and Zakri Zulkurnain. Infographics by Philip Amiote.
Special thanks to the Konrad Adenauer Stiftung - Regional Project Energy Security and Climate Change Asia-Pacific (RECAP).
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