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Sustainability Risk Management Joint Meeting – SOA, CAS, CIA Quebec City, Quebec June 18, 2008

Sustainability Risk Management Joint Meeting – SOA, CAS, CIA Quebec City, Quebec June 18, 2008. Dan R. Anderson Leslie P. Schultz Professor of Risk Management and Insurance University of Wisconsin-Madison School of Business. Image: NASA. Sustainability Risk Management.

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Sustainability Risk Management Joint Meeting – SOA, CAS, CIA Quebec City, Quebec June 18, 2008

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  1. Sustainability Risk ManagementJoint Meeting – SOA, CAS, CIAQuebec City, QuebecJune 18, 2008 Dan R. Anderson Leslie P. Schultz Professor of Risk Management and Insurance University of Wisconsin-Madison School of Business Image: NASA

  2. © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  3. Sustainability Risk Management • A. Management of emerging environmental and social responsibility risks. • B. Corporations are being pressured to address environmental and social responsibility performance, in addition to the traditional financial bottom line. • C. Make a business argument for companies becoming more sustainable by using risk management principles. • D. Sustainability risk management needs to be a critical part of enterprise risk management. © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  4. Triple Bottom Line (TBL) • Concept first articulated by John Elkington, author of Cannibals with Forks, andChair of SustainAbility, a leading consulting firm (U.K.) Financial (F) Environmental (E) Social Responsibility (SR) Performance Performance Performance Maximize F + E + SR = TBL Financial Performance F - Risk Costs of E - Risk Costs of SR = TBL Maximize TBL by reducing risk costs of E + SR © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  5. Sustainability Risks Global Warming/Climate Change Boycotts Environmental Liability Ecosystems Social Responsibility Directors and Officers © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  6. Sustainability RisksGlobal Warming/Climate Change • Earth’s Atmosphere is getting warmer and will continue to get warmer • 24 of 25 warmest years since 1980 • Warmest 1998, 2005, 2003, 2002, 2004, 2006 • The main driver is human activity increasing greenhouse gas (e.g. CO2, methane) emissions and concentrations by burning fossil fuels (oil/petroleum, coal, natural gas) © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  7. Sustainability RisksGlobal Warming/Climate Change • Overwhelming scientific evidence • Intergovernmental Panel on Climate Change (IPCC) 4th assessment (2007) • 100s to 1000s of the world’s leading scientists representing over 120 countries • 90% plus certainty, “unequivocal,” that human activity the main driver in global warming • Major scientific organizations (e.g., National Academies, American Geophysical Union, American Meteorological Society) also support © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  8. Global Warming Combined global land and marine surface temperature record from 1850 to 2006 The year 2006 was sixth warmest on record, exceeded by 1998, 2005, 2003, 2002 and 2004 Source: Climatic Research Unit and the UK Met. Office Hadley Centre Brohan, P., J.J. Kennedy, I. Haris, S.F.B. Tett and P.D. Jones, 2006 Climate Change © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  9. Global Warming Source: IPCC, 2001: Climate Change 2001: The Scientific Basis. Contribution of Working Group I to the Third Assessment Report ofthe Intergovernmental Panel on Climate Change [Houghton, J.T., Y. Ding, D.J. Griggs, M. Noguer, P.J. van der Linden, X. Dai,K. Maskell, and C.A. Johnson (eds.)]. Cambridge University Press, Cambridge, United Kingdom and New York, NY, USA. Environmental Risks © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  10. Source: www.terradaily.com, March 8, 2007 © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  11. Source: www.earthman.tv, March 13, 2007 © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  12. The images show the ice cap as it was in 1979 and the ice cap in 2003. Source: awitness.org © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  13. Property RisksGlobal Warming/Climate Change • Catastrophe Losses • – Hurricane Andrew, 1992 • Poland (floods, 1997) • China (floods, 1998) • Central Europe (floods, 2002) • Korea (Typhoon Maemi, 2003) • Florida (4 hurricanes in 2004) • Gulf Coast (Hurricane Katrina, Rita, Wilma, 2005) © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  14. Property RisksGlobal Warming/Climate Change • Munich Re, since 1960s • Frequency of weather disasters has tripled • Natural disaster damage = $200 billion(2005); $90 billion(2004) • Insured losses = $75 billion(2005); $35 billion(2004) • Research predicts • more intense rainfall • stronger storms • stronger hurricanes • sea level rises • more severe droughts © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  15. Liability RisksGlobal Warming/Climate Change • Sue countries and industries • U.S. and fossil fuel industries (coal, oil) • Coalition of environmental groups • Greenpeace; WWF; NRDC; FOE; Climate Justice • Island States • Maldives, Tavalu, Kiribati • Inuits sued U.S. (2006) • Human rights violations – threatens their existence © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  16. Liability RisksGlobal Warming/Climate Change • Katrina victims sued oil companies (2006) • Eight States (CA, CT, IA, NJ, NY, RI, VT, WI) and NYC sued 5 utilities (2004) • California sued six major auto makers (2006) • Business Insurance Poll – How serious is global warming liability risk? (2007) • 28.3% - very serious • 30.4% - somewhat serious © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  17. Life and Health RisksGlobal Warming/Climate Change Heat stress - France, 2003 - 15,000 deaths• Malaria spreads north/south from Equator• Insect borne diseases spread more easily• Impacts poorer countries (Africa, Bangladesh) more, even though they have contributed little to global warming © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  18. Sustainability RisksBoycotts Nike • Outsourcing to sweatshops • United Students Against Sweatshops • Stock price and revenues dropped • Employee morale down • Today – disclosed the names and locations of their 700 outsourcing factories • Greatly improved sustainability efforts © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008) Images: educatingforjustice.org

  19. Sustainability RisksBoycotts NGOs – Internet - send information • Instantaneously • Around the world • Large numbers of people • Virtually no extra cost © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  20. Sustainability RisksBoycotts • Revenues – profits and stock prices adversely impacted • Low Employee Morale • Reputation damage and brand tarnished “Targeting brands was like discovering gunpowder for environmentalists”- James Allen and James Root, “The New Brand Tax,” Wall Street Journal, September 7, 2004 © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  21. Sustainability RisksEnvironmental Liability • Litigation Risks • Potential environmental liability risks often build up or accumulate over a long period of time, thus when liability established, firm (or industry) faces a huge inventory of claims • Even if your current actions are within regulations and have not developed into actual liabilities, events can abruptly change your risk situation © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  22. Sustainability RisksEnvironmental Liability • Asbestos • Big Event: Dr. Irving Selikoff’s studies at Mt. Sinai Hospital in New York City in 1960s of asbestos workers. • $100s of billions • 2nd wave of litigation • Insurers paying 60% • Hazardous Waste Disposal • Big Event: 1980 Superfund (Comprehensive Environmental Response, Compensation, and Liability Act – CERCLA) • $100s of billions • To date, just clean up costs • Natural resource damages not resolved • Insurers pay 50% © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  23. Sustainability RisksEnvironmental Liability Litigation with Other Harmful Substances 1. Exxon Valdez • Oil spill – 11 million gallons • Prince William Sound – Alaska, 1989 • $3 billion cleanup costs • $900 million settlement with U.S. and Alaska governments • $5 billion punitive damages award – still being appealed © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  24. Sustainability RisksEnvironmental Liability 2. Pacific Gas and Electric • Erin Brockovich • Poisoned water with Chromium 6 around Hinkley, CA • $333 million settlement • Negative publicity – movie – Julia Roberts won Oscar • 11/03/05 – Another similar lawsuit – Contra Costa Times © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  25. Sustainability RisksEnvironmental Liability • 3. Monsanto and Solutia • Residents of Anniston, AL • PCB contamination • $700 million settlement, 2003 • 4. DuPont • Contaminated water in Ohio and West Virginia • PFOA (Perfluo-rooctanoic Acid) • Chemical used in manufacture of Teflon • $340 million settlement, 2003 • $16.5 million fine by EPA – largest ever © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  26. Sustainability RisksEnvironmental Liability • 5. General Electric • Cleanup of Hudson River • PCBs in bottom sediment • $500 million, estimated cost • Agreed to begin cleanup, 2005 • 6. Litigation in the pipeline • MTBE (methyl tertiary-butyl ether) – an additive in gasoline • Perchlorate – main ingredient in rocket fuel • Both found in groundwater systems © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  27. Sustainability RisksEcosystems • Oceans • Water • Deforestation • Biodiversity • Ecosystem • Services © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  28. Ecosystem Pressures • Fishing stocks of large ocean fish down 90% in last 50 years • Possible collapse of all fish species by 2050 • Half the world’s population will suffer water shortages by 2025 • At current deforestation rates, the Amazon Rainforest will be gone in 80 years • Great Barrier Reef may bleach out, die and collapse by 2100 • 20-30% extinction rates in next 20-30 years; rates 100-1,000 higher than before humans • Millennium Ecosystem Assessment, 2005 • 1,000s of world’s scientists • Ecosystems under major pressure © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  29. Water Water Former shoreline Vegetation Disappearance ofLake Chad in AfricaImages provided by NASA Goddard Space Flight Center Ecosystem Risks Source: United Nations Environmental Programme (UNEP) © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  30. Georgia's Lake Allatoona

  31. Lake Mead, Nevada & Arizona

  32. European UnionEnvironmental Liability Directive • Corporations Responsible for Damages to • Protected species • Natural habitats • Biodiversity • Water systems • Natural resources • Within 3 years, possible compulsory environmental liability insurance for these damages © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  33. Sustainability RisksEcosystem Services • 1. Robert Costanza, et.al., study in Nature, 1997 • Annual value of Ecosystem services: $33 trillion • 2. Loss of ecosystem services impacts peoples and industries dependent on ecosystems • 3. Firms may be held accountable for damages to these systems • 4. Liability starts with damages, and then proceeds to find accountable or negligent parties “Negligence is described as doing the same thing over and over even though you know it is dangerous, stupid or wrong. Now that we know, it’s time for a change. Negligence starts tomorrow.” – Bill McDonough & Michael Braungart, authors of Cradle to Cradle Image: conservation.org

  34. Sustainability RisksSocial Responsibility • 1. Texaco • Race discrimination employees • $176 million • 2. Morgan Stanley • Gender discrimination – female employees • $54 million settlement, 2004 • $46 million settlement, 2007 © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  35. Sustainability RisksSocial Responsibility • 3. Boeing • Gender discrimination – female employees • $72.5 million settlement, 2004 • 4. Wal-Mart • Gender discrimination • 1.6 million female workers • Largest class action gender discrimination suit ever filed • If each employee gets $10,000 - $16 billion settlement © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  36. Sustainability RisksDirectors and Officers Liability • Shareholders resolutions, boycotts and reputation • risks • “It takes 20 years to build a reputation and five minutes to ruin it. • If you think about that, you’ll do things differently.” • – Warren Buffet, CEO, Berkshire Hathaway • Loss of market value in investments • Carbon Disclosure Project report estimated that the market value of some heavy carbon emitters could be slashed by as much as 40 percent • Innovest Strategic Value Advisors report found similar results with as much as 45 percent of earnings and 35 percent of market capitalization being at risk © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  37. Sustainability RisksDirectors and Officers Liability • Transparency • Carbon Disclosure Project – Investors • Carbon Risk Disclosure Initiative – Investors • Global Reporting Initiative – Sustainability Reporting • World’s 250 largest companies - 67% have made sustainability reporting a part of risk management • Swiss Re includes in D&O underwriting © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  38. Sustainability RisksDirectors and Officers Liability • Fiduciary Duties • “The “prudent fiduciary” equation is being turned on its head. Since there is now evidence that superior environmental and social performance improves the risk profile, profitability, and stock performance of publicly-traded companies, fiduciaries can be seen to be derelict in their duties if they do not consider sustainability.” • - Matthew Kiernan, CEO Innovest Strategic Value Advisors • Sarbanes Oxley • CEO & CFO must certify • Financial statements • Internal controls are in place • Increased pressure on disclosing environmental liabilities • Increased pressure to develop environmental risk management control systems © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  39. Sustainability Risk Management • A. Must be a priority and CEO top management driven • B. Sustainability Risk Management is just high quality environmental and social responsibility management • C. Consider Producing a Sustainability, Environmental, and/or Social Report © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  40. Sustainability Risk Management • D. Waste and water reduction, pollution prevention, recycle, reuse • DuPont waste reduction saves $1.6 billion per year • Intel cut waste 50% while revenues increased 900% • E. GHG Mitigation Strategies Cost Effective • Stern Report/British Government • Cost of mitigation = 1% world GDP (Annual) • Cost from climatic impacts = 5-20% world GDP (Annual) without mitigation • F. Voluntary Reduction of Greenhouse Gas (GHG) Emissions • BP saved $1.5 billion • DuPont saved $2.0 billion © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  41. Voluntary Reduction of GHG (Greenhouse Gas) Emissions • Increased Energy Efficiency • Increased Transportation Efficiency • Employ Green Building Standards • Produce/Buy More Energy Efficient Products • Use More Renewable Energy Sources © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  42. Kyoto ProtocolGlobal Warming/Climate Change • SignedNot SignedSigned but Exempt • E.U.U.S.China • Japan India • Canada • Russia • Australia • Reduce greenhouse gasses (GHG) 5.2% below 1990 levels by 2010 • U.S. based companies – uncertainty • U.S. global companies – operate under two standards • Ill will towards U.S. as largest contributor to greenhouse gases-5% population, 22% GHG emissions • EU cut to 20% below 1990 level by 2020, vs. US increasing 20% above 2000 level by 2020 © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  43. Sustainability Risk Management • G. Manage Supply Chain • Avoid sweatshops – NIKE • Avoid dangerous products – Mattel • H. Products - Design for Environment and Life Cycle Assessment • Patagonia uses organic cotton • Timberland and Nike testing water based adhesives in shoes • I. Partnerships with NGOs • U.S. Climate Action Partnership (27 corporations, 6 environmental groups) • Rainforest Action Network (RAN) – Citigroup, Bank of America, JP Morgan, Goldman Sachs © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  44. Businesses Calling For Mandatory Greenhouse Gas Reductions • U.S. Climate Action Partnership • • 27 Corporations • – Alcan – American International Group – Boston Scientific – ConocoPhillips – Deere & Co. – Dow Chemical Co. • – General Motors Corp. – Johnson & Johnson – Marsh Inc. – PepsiCo – Shell and Siemens Corp. – Alcoa • – BP America – Caterpillar – Duke Energy – DuPont – Florida Power & Light – General Electric • – Lehman Brothers – Pacific Gas & Electric – PNM Resources • – Exelon – Rio Tinto – Chrysler • – NRG Energy – Siemens – Xerox • • Six Environmental Groups • – Environmental Defense – Pew Center on Global Climate Change • – National Wildlife Federation – Natural Resources Defense Council • – The Nature Conservancy – World Resources Institute © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  45. Sustainability Risk Management • J. Anticipate Regulatory Changes like those in the EU • Kyoto – greenhouse gas reductions • WEEE – Waste Electrical and Electronic Equipment • RoHS – Restriction of Hazardous Substances • REACH – Registration, Evaluation and Authorization of Chemicals • K. Certifications (e.g., ISO 14000), Organizations (e.g., CERES), Programs (e.g., UN Global Compact) • Worker Based Programs • Safety • Zero sexual harassment • No discrimination © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  46. Questions for Actuaries • Are Sustainability Risks Creating Potential for Long Tail Liability Claims? • IBNR loss reserves may need to be established to price risks accordingly • Claims-made policies should help to mitigate D&O, chemical, pollution and discrimination claims • Global warming/climate change and ecosystem damage claims may fall under occurrence policies, which could trigger many policy years • Even if claims unsuccessful, defense cost coverage could be large • Best mitigation strategy is to become more sustainable – more environmentally and socially conscious © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  47. Questions for Actuaries cont. • Are More Sustainable Companies Better Insurance Risks? • Travelers offered first premium discount of 10% for hybrid automobile drivers • Fireman’s Fund offering green upgrade (more coverage) for homeowners policies at no extra cost • AIG offers property premium discounts for LEED Certified commercial buildings • Swiss includes GHG strategies in D&O underwriting © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

  48. Questions for Actuaries cont. • Why? • Sustainability a proxy for quality management – including risk management • LEED Certified buildings better quality • More concerned about reputation • Worker safety a critical priority • Hybrid drivers control speed • Sustainable Companies Can Be Identified • Dow Jones Sustainability Index • 100 Most Sustainable Companies – World Economic Forum © Dan R. Anderson, UW-Madison (SOA,CAS,CIA 2008)

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