Will climate risk shape Australia’s economic future?

 This article was developed by Economist Impact, where it originally appeared. The full report, "Sight unseen: navigating out-of-sight risks," can be found online.

Like other economies in the region, Australia faces headwinds and converging macro trends that are complicating the path ahead, such as ongoing geopolitical instability and the growing proliferation of advanced technologies, to name a few. But perhaps the most pressing issue facing the country today is the intensifying climate crisis.

“Whether we like it or not, Australia is famous for its natural catastrophes—we have floods, bushfires and hailstorms,” says Greg Duncan, vice president and client service manager for FM’s Australia operations. Over the past decade, the country has grappled with a succession of natural weather events, from the summer bushfires of 2019 to the devastating floods in Brisbane and Lismore, New South Wales, in 2020.

A mounting urgency

The environmental fallout of climate change could exacerbate Australia’s ongoing water scarcity issues, a persistent problem amid the continent’s extremely arid conditions, and could endanger the country’s food security and supply chain resilience. Put together, these could be especially devastating to Australia, potentially costing its economy up to A$423 billion (US$284.2 billion) over the next four decades.

“The severity and frequency of climactic events is getting bigger and bigger,” says Andrew Stafford, senior vice president and operations manager for FM’s Australia and New Zealand operations. “Australian companies aren’t just worried about what their exposures are now, but what they could potentially be in the future.”

The scale of the crisis has also led to fears that Australia may face an “insurability crisis” as worsening extreme weather heightens the cost of maintenance, repair and replacement to properties, making premiums increasingly unaffordable.

“In towns like Lismore, you can’t buy flood insurance, and it’s become increasingly difficult to get reasonable policies for your home,” adds Mr Stafford. “Particularly in areas like far north Queensland, people won’t be buying full replacement limits, or perils like flood and wind will be excluded.”

Risks at every level

These converging risks pose major issues for Australian businesses, and taking pre-emptive measures to protect against them is essential to ensure they can continue to operate amid climate vulnerability and Australia’s economic make-up.

Nonetheless, not all companies will feel the impacts of climate change in the same way, notes Mr Duncan. “Those feeling direct impacts of climate change may be those who own or operate real estate like shopping centres, office blocks, schools or hospitals,” he says.

There are also indirect impacts as the growing climate crisis forces changes in habits not just among consumers but within the business. For example, large power companies could go from coal or gas-fired generation toward more renewable sources like solar or wind. These changes are part of a growing movement toward renewable adoption, spurred by the government’s drive toward its ambitious goal to achieve net-zero emissions by 2050.

Over the past year, the government has implemented policies to fast-track its energy transition while setting higher energy efficiency standards for transport and residential buildings. It is also using regulatory sticks, such as the proposed implementation of mandatory climate-related financial disclosures, leveraging the ISSB’s IFRS frameworks.

While necessary, these shifts could trigger a host of secondary risks, such as the vulnerability of renewable generation technologies like solar panels and wind farms to damage from hailstorms or tornados.

Growing regulatory pressure also poses compliance risks for companies, says Mr Stafford. “There’s some confusion among the risk managers of Australian corporates as to what their obligations are, what are the easiest ways to comply, and what are the impacts if they don’t comply.”

The energy sector itself could face hurdles as it transitions toward renewables and more sustainable generation methods. Aside from possible supply chain disruptions or high investment costs, Mr Duncan points out that the gradual obsolescence of existing technologies could stymie power companies’ progress.

“Consider assets like traditional thermal generation; as these units age, their risk profiles are changing,” he explains. “As you get closer to end of life, there's a risk that not enough is invested to maintain them, and if there is a major interruption, it could really upset the balance across the entire system and network.”

These risks sit alongside others such as the financial and operational challenges of adopting relatively nascent technologies. “If you’re spending a lot of money to build a wind farm but you’ve also got a more efficient and cheaper generator, there’s a redundancy risk,” says Mr Duncan. “The economics of this are uncertain, whether it’s the inputs, revenues or costs.”

Changes in infrastructure could similarly introduce new, unexpected risks. Mr Stafford raises one example: While a move from dams to desalination plants to bolster water security is well-intentioned, businesses considering this shift might not be thinking about the knock-on changes in risk levels. Desalination plants are inherently riskier to operate than static dams, and businesses unperceptive to this could be left unprepared and vulnerable to being caught off guard.

Riding a wave of rich data

According to Mr Stafford, Australia’s so-called “insurability crisis” is somewhat a misnomer. He attributes that view to the lack of quality data for insurers to understand and differentiate risks.

Across Australia’s thousands of councils, for example, there is no consistency in how flood maps are developed or maintained to factor in the effects of climate change. Part of the problem is that insurers today, who still rely on generalised actuarial models, are unable to provide affordable insurance to customers in Australia’s most exposed regions.

Fundamentally, the challenge facing companies—and insurers—is a question of data and research. A risk mitigation approach rooted in deep research can tackle this “uncertainty”, as Mr Duncan puts it. “Insurers don’t like uncertainty, but if you can overcome it then you’re in a better position to understand and manage risks,” he says.

Driven by this, FM takes a boots-on-the-ground approach and a hyper-local understanding of its clients’ risks and needs. For example, teams of expert FM engineers make regular site visits to advise clients on property design and risk mitigation; this information is then transmitted in the form of detailed maps that indicate flood-prone areas, as well as engineering risk reports that help illustrate how clients’ risks currently stand, as well as future predictions based on different scenarios.

“Where FM supports our clients is in providing them with the information to help them understand what their exposures are to climate perils and make decisions,” says Mr Duncan.

This data-driven approach also starts high up in the value chain, as FM invests heavily in research into building materials, most of which occurs at its Research Campus in Rhode Island in the United States and its experiential risk management facility in Singapore.

“For 185 years, FM has been working with clients to understand how different materials burn and respond to windstorms and quakes, and every new material we encounter goes down a research path,” says Mr Stafford, citing notorious materials such as the aluminium composite panelling involved in the 2017 Grenfell fire that occurred in London. Teams from FM approvals, the company’s third-party testing and certification offering, have also worked with designers to create hail-proof panels to lessen the impact of storms on these fragile technologies.

“We’re best when we get involved at the design stage of any new build, whether it’s a greenfield or brownfield project,” says Mr Stafford. “We can provide consultation on which alternative materials will perform better against fire or windstorms, and if we can do it upfront, we’ll get a more resilient building straight away.”

At the forefront of emerging risks

Both Mr Duncan and Mr Stafford express confidence there is significant momentum among Australian companies toward building resilience against climate change through data-backed engineering and risk mitigation, as illustrated by the fact that Australia is FM’s fastest growing market outside the United States.

But as the climate crisis worsens, the insurance industry will have to continually evolve to close gaps, especially when it comes to Australia’s most vulnerable communities.

“The Insurance Council [of Australia] is very concerned about the lack of government investment in building a resilient landscape with levies or strategies to mitigate the impact of urbanisation,” says Mr Stafford. Mindful that the investment shortfall is limiting the affordability of insurance for middle-class families, FM for example is offering support via influencing codes and standards to build facilities and providing public access to some of its data that will help make better decisions.

“When you look at the world of risk, it does feel like things are getting riskier and costlier,” says Mr Duncan. “But on the flipside, offsetting that is a maturing insurance industry that is becoming more sophisticated, with more technology and data at its disposal.”

“It’s all sort of coming together,” adds Mr Stafford. “It’s listening to the clients and picking up what they’re looking for. Our climate-related products are resonating—they’re putting them in a stronger position.”