Resilience Insights Series: Part 4
Pandemics, geopolitics, technological change, urbanization, climate change, and demographic change all present significant threats, but they also pose opportunities for those with the foresight and agility to invest in resilience. The International Standards Organization defines organizational resilience as “the ability to absorb and adapt in a changing environment.” Building resilience requires understanding and proactively managing risk, while at the same time building adaptive capacity.
Managing risk requires understanding what can go wrong and how to prevent damage. Adaptive capacity involves knowing what needs to go right and having the flexibility and foresight to create value out of change and uncertainty. Adaptive capacity can be created by alleviating underlying stressors that make people, organizations, and systems more vulnerable, and at the same time building informed and empowered teams.
Climate change is best viewed in this larger context of risk and adaptive capacity. Even under the most optimistic scenarios, extreme climate-driven weather events will continue to increase in severity and frequency around the world, a trajectory that is already well established. Disruptive events will continue to result in property losses as well as dynamic economic impacts and social disruption.
The real asset industry is only just beginning to develop rational, systematic strategies to manage this increased variability. Beyond preventing losses, the real asset industry can also serve as a stabilizing function in the local markets where their assets are located, while also creating new business value, by building physical, economic, and social resilience.
Of the 2020 Resilience Module participants, 85%, 75%, and 58% (Real Estate, Infrastructure Fund, and Infrastructure Asset, respectively) reported having a systematic process to incorporate climate risk and resilience into planning, budgeting, evaluation, and/or similar activities.
Real Estate participants demonstrated higher rates of integration across risk type and integration method as opposed to Infrastructure participants. Across integration method, well-defined climate-related risks are generally easier to incorporate than, often times less-quantifiable, social risks. Finally, work plans seemed to be the most systematically leveraged integration method of resilience issues.
Risk and Resilience Toolkit
The GRESB Resilience Module demonstrates that more organizations are beginning to think about resilience. The first step for most organizations involves conducting high-level risk assessments. But for risk assessments to matter, they must influence decision-making. Real estate companies have a range of approaches available to them to address physical and transition risks.1 Proactive companies use the following risk management and resilience tactics to some degree and can articulate their approach within investment documents.
- Avoid – It is often said that the best way to prevent flood damage is to not build in a floodplain. While climate change is global, its impacts will not be shared equally, and some places are more exposed, and thus present more risk, than others.
As many major markets are in high-risk areas and unpredictable disruptions can arise in any location, the ability to simply avoid risk may have limited applicability for existing assets in the built environment. This doesn’t mean that smart investments can’t be made in areas with high hazard exposure. Rather, companies should be asking more questions about specific sites and selecting lower-risk sites when possible.
To date, there is little evidence that investors are fleeing areas with high climate exposure, although some the value of some properties that are perceived to be at risk of sea level rise seems to be declining compared to properties at higher elevations. The value of the asset, the underlying value of the location, and the diversity of assets across a portfolio must be factored into the equation. Furthermore, there is a potential compounding problem that as capital flees particular markets to avoid climate risk, local resilience can be further undermined.
- Mitigate – When risks exist cannot be avoided through site selection, they can often be mitigated to some degree at the site level. Examples of mitigating risks may include:
- Designing new facilities in ways that can withstand or adapt to future climate conditions
- Hardening infrastructure to make it more robust
- Softening infrastructure (e.g., by using natural systems) to make it more flexible and adaptable, and to provide environmental and social co-benefits Retrofitting existing facilities to make them more durable and flexible, and to protect the most sensitive and critical functions from being damaged
- Deploying “safe to fail” measures so that disruptions do not cascade through the system and create chains of failures
- Building in redundancy and diversity in critical functions to provide backup to failures at one location (e.g., relying on multiple data centers instead of one or developing on-site energy resources that can be islanded when the grid goes down)
- Diversifying, simplifying, and localizing supply chains
- Anticipating and proactively addressing future climate-related policy changes (e.g., by planning ahead for decarbonization and electrification)
- Proactively divesting from carbon-intensive assets to avoid future economic and/or reputational damage
Some of these measures can have multiple benefits, such as “softening” infrastructure that protects against flooding while providing habitat and space for recreation, or adding shade and cool surfaces, which keep places healthier and safer while reducing energy demand. These co-benefits can be calculated and used to justify investment. Other measures, such as flood protection or seismic retrofits, may have no immediate or direct co-benefits in the absence of disaster but may be justified for their risk-reduction potential alone.
In either case, mitigation measures should be evaluated compared to the cost of doing nothing. FEMA estimates that every $1 spent in mitigating damage from natural disasters is worth $7 in recovering from that damage. That figure includes only investment in physical retrofits of infrastructure and doesn’t capture any business continuity or social co-benefits, which would make that ratio even greater. Identifying a coherent strategy around valuing risk and managing uncertainty can change the economics of investment in mitigation measures as well as change the value proposition of alternative measures, especially compared to the potentially catastrophic cost of doing nothing.
- Transfer – Risk transfer means paying someone else to assume the risk for you. Risk can be transferred through proper insurance and underwriting. This has been the most common approach in the real estate sector and will likely continue to be so for some time. But the insurance industry is also working to manage climate risk, in ways that will dramatically change the availability, coverage, and cost of policies.
The frequency, size, and cost of natural and climate-driven disasters are increasing globally.2 This is having a direct impact on the availability, cost, and coverage of insurance in specific markets. For example, following major wildfires in California, many insurance customers saw their insurance costs jump dramatically,3 until the California Insurance Commissioner issued a 1-year moratorium on insurers canceling policies.4
While many people had hoped that the insurance industry would incentivize investment in risk mitigation (providing a cost-saving benefit analogous to energy savings from investment in energy efficiency measures), that cost savings hasn’t materialized. Instead, insurance costs are likely to rise, and in some cases policies may simply not be available. Risk analysis can help companies verify that they have appropriate insurance coverage based on the exposure to hazards and value of their assets.
Even with proper policies, insurance cannot cover all losses. According to Aon, 2020 saw US$268 billion in global losses from natural disasters, but only US$97 billion was covered by insurance, leaving a 64% global protection gap. Transferring risk is a key part of a comprehensive risk management approach, but it cannot be the only part.
- Manage – Risk can never be fully avoided, mitigated, or transferred, and must therefore also be managed. Additionally, some risks are unforeseeable and can only be addressed through building adaptive capacity. This requires organizations to shift from being reactive, responding to each event as a one-off situation in an ad hoc way, and moving toward a more systematic and proactive approach. Proactive organizations acknowledge that disruption is inevitable and make sure that backup systems are implemented and maintained, real-time data is available, and roles and responsibilities are well-understood, even under changing or uncertain conditions. Strategies for managing risk and resilience might include:
- Developing strong and coordinated incident response and business continuity plans
- Mapping value delivery chains and understanding critical functions and systems required to maintain value delivery across a range of operating conditions
- Developing strong connected teams who can work across departmental siloes to solve problems in real time
- Establishing relationships and agreements with local partners for mutual support
- Investing in local resilience-building measures to support the systems that assets rely on, including infrastructure and communities
- Planning in advance for recovery
These types of actions can help organizations continue operating when their peers may falter. For example, some organizations may require diversifying and backing up on-site energy sources with a combination of solar generation, battery storage, and microgrids with islanding capacity to increase energy resilience. For others, it may require the ability to redeploy personnel to manage different kinds of tasks during disasters. And for others, it may require diversifying business models or expanding the types of value they deliver.
- Leverage – Investors are in the business of translating risk into value. Organizations that understand their risks and are actively managing them are then well-positioned to leverage those risks. That can mean very different things depending on the organization’s business model. For real asset companies, measuring and parameterizing risk can help them negotiate stronger deals that accurately price that risk. It may also enable companies to leverage their position as good corporate citizens or less risky companies in order to gain public support or expand market share.
- Accept – Some risks cannot be reduced or managed through the tactics listed above. In those cases, companies may simply accept those risks. Acceptance of risk is distinct from ignorance or denial of risk. Proactive organizations that have a clear picture of the climate risks they face must decide which risks are acceptable and which are not. This level of acceptance might change over time as the threat of climate impacts intensifies.
Many real asset companies accept certain levels of risk based on how long they plan to hold an asset in a specific location. They might adopt a plan based on flexible adaptive pathways. For example, they may choose to remain in exposed coastal locations until sea levels have risen to a prespecified level or they might wait to replace heat-sensitive equipment in an infrastructure system until temperatures have warmed above a particular threshold. It is important to remember, however, that many climate-related risks are driven less by average changes (e.g., sea level rise or average temperature increase) than by peak events (e.g., storm surges or heat waves).
- Transform – Organizations that actively work to manage risk and build adaptive capacity in a comprehensive and systemic way often find that they set out to solve one problem and end up experiencing unforeseen benefits. Herein lies the real promise of resilience. Organizations that understand their systems and take proactive steps to build in diversity, flexibility, and redundancy are better able to position themselves within their markets, better able to expand to new markets, and better able to recover and even “bounce forward” from disruptive events. Examples of transformative measures include:
- Empowering leaders throughout the organization to find new approaches to solving problems
- Regularly conducting multidimensional scenario-planning and horizon-scanning exercises to inform decision-making
- Working to not only manage risk from hazards but to also alleviate underlying stressors that make systems, assets, operations, locations, and communities more vulnerable
- Deploying digital tools and information-sharing platforms to enable real-time flow of relevant data across departments
- Taking every disruption as an opportunity to learn and improve, and supporting a culture of continual improvement
Real Estate 2020 Resilience Module participants tended to have implemented resilience-related business strategies with regard to their entities at a greater rate than did Infrastructure Fund participants, than did Infrastructure Asset participants. While standing investments tended to be the target across participant types, this could also reflect the composition of the participating entities.
New construction project strategies included minimum design standards for energy efficiency, energy demand management, certification standards, integration of renewable energy, climate sensitivity assessments, and use of low-embodied carbon materials. Standing investment strategies included CRREM scenario analysis, physical climate risk analysis, implementation of operational green building certifications, and evaluation of on-site renewable energy opportunities. New acquisition strategies included much of the same. In general, there was significant overlap between efforts across each investment type.
A comprehensive approach to climate risk and resilience will employ all of these tactics at different times. Proactive companies are becoming increasingly explicit and articulate about when and how they will take each of these approaches, both internally and externally. Different sets of tactics may be appropriate for different investment types, asset classes, or investment horizons. With clear decision-making frameworks, strategies can also be deliberately deployed organizationally to create central guidance for all projects and processes.
As organizations mature and build a culture of resilience, they often find that they are able to do more than prevent damage and loss — they are able to recognize and respond to new opportunities, support their internal and external stakeholders, and add value in new ways irregardless of the challenges that come their way.
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