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The climate risk you may not be thinking about

Is your business prepared to adapt to an increasingly volatile present?

Much of the world today — where we live, what we eat, what we do — is built on the basic assumption of a stable climate. However, our physical, social and economic systems all assume historical climate parameters that are increasingly outdated in the face of rising temperatures and more extreme weather events.

That means the most significant risk from climate change in the near term is not from a future of extreme weather — we know it is coming — but whether we have adapted to an increasingly volatile present.

Take a snapshot of the past few months: A heatwave in Europe, severe drought followed by monsoonal flooding in India and another devastating hurricane in the Caribbean. These are acute or extreme climate events. But the world is also increasingly contending with the chronic impact of climate change, long-term shifts in averages like an increase or decrease in the average annual amount of rainfall for a specific region.

Hotter summers and warmer winters drive changes in rain and snowfall, increasing risks at both ends of the spectrum — severe drought and extreme flooding. Rising temperatures are increasing the risk of heat stress, causing sea-level rise via the thermal expansion of water and melting of land-ice, driving changes in ocean current patterns (which affect the way the ocean moves and stores both heat and atmospheric CO2), as well as increasing tropical storm severity.

It only takes one big storm to reveal how brittle our seemingly robust systems really are.
Extreme weather disrupts human activities by threatening the health, safety and livelihood of large populations. As climate hazards intensify and become more frequent, the damage to our global socio-economic system will increase, threatening to upend our assumptions about future growth and prosperity. (In forthcoming research from the McKinsey Global Institute, we explore physical climate risk in detail and quantify how much already exists in our global socio-economic system).

Throughout the global economy, investing, buying, selling, borrowing and lending all require confidence that basic assumptions will hold true. Look at the movement of goods, services and people around the world. Global supply chains and just in time inventory are designed with efficiency in mind, typically without provisions for climate disruptions. But is that still adequate? Consider how extreme flooding in Thailand in 2011 disrupted global production of hard drive disks (PDF), among other products, and doubled prices on the global market.

Then look at infrastructure — the power grid, transport network, water supply and telecommunications systems that form the backbone of the global economy. These systems are often outdated but critical to communities and local economies. Few are ready to handle more frequent and more severe climate hazards. 

And it only takes one big storm to reveal how brittle our seemingly robust systems really are. Recall what happened when Hurricane Sandy struck the eastern seaboard of the United States in 2012. Subways, airport and roads were flooded, grinding transportation to a halt. Millions lost power, some for days and weeks, shutting down businesses, creating public safety issues and forcing many cell phone towers offline. Eleven billion gallons of sewage flowed into rivers, bays and coastal waters because severe inundation overwhelmed municipal wastewater systems. In total, the storm was one of the costliest, resulting in about $70 billion in damages.

And it’s not just commerce and infrastructure. Biological systems are also very sensitive to climate shifts. Take agricultural yields for example. Corn, a major global commodity, has a physiological limit at about 30 degrees Celsius beyond which yields decline dramatically.

Corn, a major global commodity, has a physiological limit at about 30 degrees Celsius beyond which yields decline dramatically.
Over the next decade, current warming trends are essentially baked in. Global average temperatures already have increased, setting in motion the conditions for more extreme weather events. Even if major environmental policy changes are implemented immediately, they only will affect the trajectory of warming starting a decade or more into the future given system lag effects.

And consider the role of financial markets in all this. Once physical climate risk has become transparent, financial markets will bring forward tomorrow’s impact to today. Are we ready for the impact on the prices of stocks, bonds and property?

At the same time, insurance losses likely will increase as a 1 in 100 year event becomes 1 in 10 or 1 in 5, and chronic changes to the climate stress systems that have been designed and optimized for a set of conditions that, in some regions, may change dramatically.

Similarly, insurers’ investments, particularly those of life insurers and pension funds, may be more exposed due to the long duration of their investments. Solutions to these challenges include using climate models to better assess risk, and innovations such as parametric pricing, insurance-linked securities and public private partnerships to manage exposure. Either way, the insurance market is set to grow and change significantly.

So the time to adapt is now. Assess the risk that systems within or connected to your enterprise, community or home may fail as climate becomes increasingly volatile. Act and invest to increase safety, protect asset values and secure cash flows. And it all starts with changing our assumption of a stable climate.

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