Author: Lisanne Sison
In biology, an ecosystem is a physical environment where plants, animals, humans, and other life are connected and impacted by the physical geography where they coexist, and the climate and weather around them.
A business ecosystem functions largely the same way: It's a complex, interconnected network that's tightly correlated with its business environment. By leveraging an ecosystem approach with Environmental, Social and Governance (ESG) risks, businesses can improve their long-term sustainability, increase stakeholder engagement and achieve a competitive advantage in the marketplace.
Connected Extremes Drive Compounding Risks
In June of 2020, an article published in the journal Nature titled "Understanding and managing connected extreme events" presented a multidisciplinary argument for how extreme events are connected and require an interdisciplinary and coordinated approach. Notably, the article connected societal drivers such as urbanization, water management, land use, forest management and other activities with climatic drivers that affect various hazards. For example, urbanization and deforestation contribute to increases in temperature, which in turn contribute to heat and air pollution.1
In addition to illustrating the various drivers of specific hazard events, this article further described societal impacts of connected extremes in five major sectors, including food, water, health, infrastructure and insurance. Below, I illustrate how these five major sectors are connected and part of a broader hazard ecosystem.
Scenario of a hazard ecosystem
Let's start with water. Though California has had a record-setting year for precipitation across the 2022-2023 rainy season, it follows multiple years of severe drought that drove up the risk of wildfires. In 2021 alone, there were nearly 7,400 wildfires, burning over 2.5 million acres, impacting nearly 4,000 structures and resulting in the deaths of three firefighters. The total damage of the 2021 wildfire season in California alone was estimated at $45 billion to $55 billion. The resulting smoke-degraded air quality and increased pollution are associated with increases in emergency department visits for respiratory conditions such as asthma, with a disproportionate impact on the elderly and those with other underlying health conditions.
In addition to fire risk, the drought significantly impacted food availability and prices. According to a 2021 drought impact assessment conducted by the University of California, Merced, the drought reduced surface water deliveries in 2021 by 5.5 million acre-feet (maf).2 As a result, farms increased groundwater pumping by about 4.2 maf, with a net reduction of 1.4 maf of water. This reduction was correlated with an estimated direct economic cost of $1.2 billion, and approximately 8,700 full- and part-time job losses. Major crops impacted included rice, cotton, grain and other crops. Rain-fed feed crops and pastures suffered sizeable losses as well, impacting some dairy farms and increasing the overall acreage of idled land. Collectively, these losses led to some food shortages and impacted supply chains, and the increased costs of milk, beef, grain and other items were passed on to consumers, resulting in higher food prices and contributing to inflation.
Just this one example of a single year of drought illustrates the connected impacts on water, food, health, infrastructure and insurance, in addition to the overall economic impact. If you compound this event with increasingly severe hurricanes and weather events in other parts of the country, a more complex ecosystem of interconnected risks begins to emerge.
Relevance to risk management and insurance
From an insurance perspective, these compounding events and losses continue to drive up the cost of property coverage. According to the National Oceanic and Atmospheric Administration (NOAA), the US has sustained 348 weather and climate disasters since 1980, where overall damages/costs exceeded $1 billion. The 1980-2022 annual average was 8.1 such events, but the annual average for the last five years (from 2018 to 2022) increased to 18 billion-dollar events per year.
This increase in overall probability has necessitated a shift in how insurers estimate and quantify the potential impact of various hazards. In addition, the volatility and uncertainty of these events have increased the importance of having accurate property valuation data, solid forecasting models, and an understanding of key vulnerabilities and contributing factors. It's also important to understand these hazards and how they interconnect to other exposures.
The natural ecosystem isn't separate from the business ecosystem, and a collaborative and integrated approach is required to tackle both the drivers and impacts of these scenarios on organizations. Using a risk-based approach, such as enterprise risk management, can help organizations understand which natural exposures are material to their business, guide the identification and implementation of appropriate mitigation strategies to address their ESG risks and support more resilient operations.