01 Feb 2010
Corporate organisations today face two major and not always complementary challenges with regard to sustainability. Especially in the finance sector, institutions need to clean up their own houses and ensure sustainability is deeply embedded in the fabric of their core business – a language of corporate sustainability will have little credibility if an organisation is failing to manage its core operational risks or maintain a sustainable business model.
At the same time, they are being exhorted to step up and play their role as stakeholders in global issues such as climate, food security and human rights. In this sense sustainability has both an internal aspect; about how can we better manage the long-term risks and opportunities we face, and a broader external aspect; about how we can contribute to the broader goals of sustainable development.
This article explores how both these issues affect Swiss Re, the first through the exploration of what corporate sustainability is and how it relates to integrative risk management, the second through a practical example of how different stakeholders can collaborate to contribute to sustainable development.
Corporate Sustainability after the financial crisis
One potential trap in discussing sustainability is to consider it a fixed and well-defined concept. In practice, the idea is evolving as corporate organisations struggle to define their role within societies that embrace global approaches, but remain culturally and politically very distinct. From being giants striding across the globe in the vanguard of liberal economic globalisation, many large corporates have increasingly experienced the complexity of maintaining a common set of values across disperse geographies and cultures. This has been exacerbated by the accelerated flow of information and media both from within and without the organisation, which has increased the spotlight on their activities and removed the careless excuse that dubious practices can be accepted on a local basis if they fit with local cultural norms. The result has been much reflection upon what it is for an organisation to promote and live out a set of values and to recognise its responsibilities to different stakeholder groups that are affected by how it does business.
Additionally in the wake of the recent financial crisis fundamental questions have been asked about the sustainability of institutions that have made significant profits whilst not effectively managing their underlying risks and exposing themselves to systemic risk. What began as a crisis in the US sub-prime mortgage sector in autumn 2007, has become the worst global recession in decades. Collapsing credit markets led to a freeze in liquidity, affecting most asset classes and many leading financial services companies. The IMF estimates that total losses for the financial services industry will amount to USD 1.4 trillion, of which banks are expected to bear between USD 720-820 bn and insurance companies between USD 160-250 bn.
This crisis has deeply affected the reputation of the financial services industry. When risks were not properly identified, it was inevitable that concerns would be raised about the effectiveness of existing self-governance and risk management practices. Short term profits may have appeared to be of greater significance than safeguarding the long term viability of large and long-lasting institutions.
Defining corporate sustainability
The concept of sustainability shares some of the characteristics of leadership: it appears often easier to recognize in practice than it is to provide a tight definition or blueprint. However there are some clear characteristics which can lead to a working definition:
Sustainable action is to act in accordance with the core values of an organisation, taking into account the different stakeholders, how they are affected by decisions made and with an integrated assessment of the risks and opportunities faced.
Within this definition there are at least three key concepts that deserve comment:
Different stakeholders: Shareholders and investors remain a key stakeholder group and their desire for profit and dividends is respected as a key priority. Other groups, however, also have a vital stakeholder role for any corporate organisation; from employees through regulators, governments, and the general public. Sustainability for a corporate organisation requires it to take account of these relationships and engage in dialogue with them in a context of trust and transparency. This dialogue is a two way exchange of views and values that respects differences and seeks to learn from the different perspectives and skills stakeholders bring to an issue. Swiss Re founded the Centre for Global Dialogue for exactly this reason in 2001, namely to explore emerging risks and difficult issues, where solutions can only be developed through the commitment of different stakeholders to both engage and accept change.
Value-based action: Most large corporates have struggled with the challenge of defining a set of values that reflect both how they practice and how they aspire to behave. The struggle has been that several high-profile failures of ethical corporate practice have been connected to organisations, such as Enron, who were leaders in espousing corporate values. In this sense, the proof of sustainability is in what one does and not in what one says: To act sustainably is not to do something extra but rather to undertake the core purpose of the organisation in a responsible way, in line with the core values, regardless of short-term financial gain.
Integrative risk management: Engaging in business should generate both risks and opportunities. Companies need a holistic view of the risks faced, supporting the capacity to make decisions and steer the business in line with its strategy.
The major way in which Swiss Re can embed sustainability into the core of its business operations is through integrative risk management. Our business opportunities and major challenges come from the world’s changing risk landscapes. We seek to reduce the financial uncertainty associated with the risks our clients take, enabling them to get on with their core business. To achieve this we have frameworks for managing emerging risks and addressing key industry issues. This requires a collaborative approach, drawing on risk experts from across the business and creating a dialogue with external stakeholders to build a holistic picture of the risks faced and what we can do about them.
The first step in ensuring good risk management governance is to ensure all regulatory demands are met; full definition and documentation for the acceptance and administration of risks within the organisation, including the audit and review of any models used, and their appropriate disclosure. But the implementation of risk governance and management processes is only one step in mitigating the risks a company faces and therefore acting sustainably. The recent financial crisis was not caused so much by a failure to follow standard procedures and respect guidelines: the heart of the matter was that the assessments of the underlying credit risks were flawed. So, whilst clear structures and processes are vital, recognition is needed of the cultural aspects of risk management that can help individuals act in a decisive and pre-emptive way, often against the prevailing opinion.
This then provides a short working definition of sustainability from the perspective of a corporate organisation. It provides no guarantee against mistakes, nor does it lock-in future profitability. What it will do, however, is provide a sound underpinning on which to hang the delicate fabric of trust and transparency that is key to dialogue and sound governance across geographies and stakeholder groups.
A missing link to broader sustainable development
The final factor which has not been discussed from the above working definition is how stakeholders, and these would include those who represent the environment and vulnerable social groups, are affected by the activities of the corporate organisation. This is the part of the definition that connects the values and activities of the corporate organisation with the external environment and asks what contribution it is making to overall sustainable development.
Sustainable development is often seen to have received serious attention in the wake of the Brundtland Report. Published in 1987 and also known as Our Common Future, it alerted the world to the urgency of making progress toward economic development that could be sustained without depleting natural resources or harming the environment. Sustainability here was defined in the context of sustainable development: “development that meets the needs of the present without compromising the ability of future generations to meet their own needs.” In a more colloquial way one could say “do not do things in such a way that your children will not be able to do them also.”
The Brundtland Report was primarily concerned with securing global equity, redistributing resources towards poorer nations whilst encouraging their economic growth. It suggested that social equity, economic growth and environmental maintenance are simultaneously possible and vital to sustainable development. The environment should also be conserved and our resource base enhanced, by gradually changing the ways in which we develop and use technologies.
Climate change and adaptation
One of the areas which deeply affects sustainable development and the core business of Swiss Re is climate change. The fact that 36 of the 40 largest insurance losses since 1970 have been caused by severe weather events is perhaps explanation enough for why a reinsurer such as Swiss Re should be concerned by climate change. We have followed this issue for over 20 years when we first identified it as an emerging issue. In line with the best scientific thinking, we believe the case for action on climate change is overwhelming. If emissions continue to rise at the rate of the last 30 years, atmospheric concentrations will potentially increase to 700 parts per million (ppm) or more leading to a long-term global increase of 6°C or more. To put this into context, The Stern Report estimated that a 5°C rise in temperature could reduce global GDP by up to 10%. Such temperature rises would increase the potential for catastrophic change: for example, sea-level would rise up to seven metres if the Greenland ice were to melt (IPCC 4th report).
Despite the complexities of reaching a global agreement at Copenhagen in December 2009, the need for a long-term, market-based policy framework with clear reduction targets wherever possible and a ‘cap-and-trade’ carbon market system remains. If possible, we need a reduction of 20-30% by 2020 and 50-80% by 2050 compared with 1990 levels, keeping atmospheric greenhouse gas concentrations between 450 and 550 (ppm) or 2-3°C.
However, while a global agreement in Mexico would be most welcome, there is also a reality that societies need to face; the slower we are to reduce global emissions in the next decades, the more we will have to adapt to the effects of climate change. Additionally, there is potential that increasing the resilience of economies to climate change can boost economic development.
Background to the Economics of Climate Adaptation Working Group
In order to assess how adaptation could work in practice, Swiss re joined a multi-stakeholder group. The Economics of Climate Adaptation (ECA) Working Group was formed in September 2008: the Global Envrionment Facility (GEF) was the initiating sponsor, McKinsey & Company and Swiss Re acted as analytical co-leads, and ClimateWorks, the European Union, the Rockefeller Foundation, and Standard Chartered Bank provided key data and experience.
The Working Group set out to develop a practical framework, grounded in robust analysis, which would allow national and local decision-makers to assess the “total climate risk” facing their economies, and to minimize the cost of adapting to that risk by implementing detailed cost-efficient measures. Detailed case studies tested the framework in eight different climate-sensitive regions and cities – across China, Guyana, India, Mali, Samoa, Tanzania, the UK, and the US.
Overall ECA findings
1) Significant economic value is at risk. Economies already face very significant climate risk: if current development patterns continue to 2030, the locations studied will lose between 1 and 12% of GDP as a result of existing climate patterns, with poorer populations such as small-scale farmers in India and Mali losing an even greater proportion of their income. Even within the next 20 years, climate change could increase these losses significantly: in the areas studied, climate change alone drives 45-70% of the expected loss from total climate risk to 2030.
2) In all the cases studied, there is a portfolio of cost-effective measures to address the risk identified. In the locations studied, between 55 and 95% of the loss expected to 2030 – even from severe climate change impacts – can be averted through adaptation measures that are already known and tested, and whose economic benefits outweigh their costs. These measures include infrastructure improvements, such as strengthening buildings against storms or constructing reservoirs and wells to combat drought; technology, such as improved fertilizer use; and systemic or behavioral initiatives, such as awareness campaigns. As part of this portfolio, risk transfer or insurance measures have a key role to play in addressing low frequency/high severity weather events such as one in 100 year floods.
3) In the medium term, adaptation can pay for itself. A balanced portfolio of adaptation measures can have a profound and positive impact on economic development. Consider the example of one of the locations studied, Mopti region in Mali, which faces the threat of a gradual southward shift of the arid Sahara. The case found that cost-effective measures to bolster cash crops would generate new revenues large enough not only to compensate for Mopti’s climate-related losses, but for those of the entire country. Even in the non-agricultural studies, the economic benefits of adaptation outweigh the costs in almost all cases. The opportunities to target adaptation funding better – and to attract investment for climate-resilient development – are tremendous.
4) Residual risk from climate change is not uninsurable – risk transfer measures can play an expanded role. While infrastructural, technological and behavioral measures can together avert much of the expected loss in the locations studied, they are often not cost-effective for addressing infrequent extreme events, such as major droughts or one in 100 year floods. As part of an integrated portfolio of measures, risk transfer measures can play an important role in protecting people’s livelihoods from such events – even amongst lower income households in developing countries
5) These measures are in many cases also effective steps to strengthen economic development – especially in developing countries. In Mali, for example, the implementation of climate-resilient agricultural development could bring in billions of dollars a year in additional revenue. Such measures, with demonstrated net economic benefit, are much more likely to attract investment – and trigger valuable new innovations and partnerships.
To look more closely at the outcomes from the ECA case studies let us take the example of China. Although China is also at risk from flooding and wind impacts, drought constitutes the largest threat to food security and rural social benefits. Researchers evaluated the loss incurred at USD 8 billion in economic losses, affecting 21 million hectares of crop fields and leading to the suffering of 140 million people annually in recent years.
The test case focused on the important crop growing regions of North and Northeast (NE) China, which will likely produce 25% of China’s food crops by 2030, because they are the most vulnerable areas to drought in terms of historical loss and size of crop land affected. In order to understand the potential impact of climate change on drought loss in North and NE China, projections were made under three scenarios: Today’s Climate, Moderate Change and High Change based on the defined parameters of the Inter-governmental Panel on Climate Change (IPCC).
The case study revealed that by 2030 climate change could lead to a 50% increase in annual drought loss in NE China to USD 1.7 billion, compared with a 6% rise in North China, still to a tremendous amount of USD 0.9 billion. The different impacts are due to regional differences in climate, crop structure and capability to fight drought. The implication for decision-makers is therefore that there is no “one-size-fits-all” approach to adaptation. Highly region-specific analysis should be undertaken to define the appropriate adaptation strategy and measures.
The case study determined four groups of measures that will be key to reducing drought loss in North and NE China:
1) Irrigation: Anti-seepage materials along water-conveyance channels; use of plastic and concrete pipes to convey water from source to field; expanded drip and sprinkle irrigation.
2) Planting: Protective soil cover that prevents water evaporation and keeps temperatures consistent; soil-conservation techniques.
3) Seed-engineering: Making use of more drought-tolerant plants through conventional breeding.
4) Engineering: Building of reservoirs and pond dams to store water for drought seasons; micro-water storage facilities for emergency use in mountainous areas.
These measures require a total capital investment of USD 15 billion in North and NE China, and have the potential to avert 50% of drought loss by 2030.
Agricultural insurance as risk-transfer tool in addition to adaptation measures
The study also identified the value of agricultural insurance to transfer risk in the case of extreme (ie infrequent but very severe) droughts. Analysis suggested insurance could cover some USD 105 million in the North and some USD 145 million in the NE. Assuming only 30% of the loss is claimed would result in coverage of around 10% of the total drought loss. Agricultural insurance would help to protect farmers against high losses to their income, and make it possible to quickly rebuild their livelihoods in the event of a disaster; additional risk transfer instruments would reduce the financial burden on the government in providing disaster relief. As a result, the Chinese government has promoted agricultural insurance strongly in recent years.
Considerable collaboration will be required between major players and the Government to implement the measures identified. The key action for government would be to establish an all-encompassing regulatory framework with clear policies and incentives in place to ease implementation. The private sector must also play a role, not only in developing goods and services, but also in contributing their know-how and expertise.
The ECA Working Group provides one template for how sustainability can be seen and defined in action. Most importantly, the framework provides a contribution to how developing economies can adapt to the serious consequences of climate change. In the context of this brief article, it also provides an example of how corporate organizations can combine the future of their business models with addressing the concerns and needs of their broader stakeholder groups to give depth and meaning to the notion of corporate sustainability.
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