Embracing Sustainability: Managing the Risks

The Drive for sustainable performance has put pressure on executives to disclose more about the interactions between their corporations and their stakeholders. For risk managers, sustainability presents both challenge and opportunity regarding responsible behavior. New areas of risk greatly expand their responsibility, but a lack of traditional solutions to some emerging risk areas requires risk managers to develop new approaches involving noninsurance strategies.

Sustainability embraces a wide range of issues, from renewable resources to social and employment practices. Understandably, many firms find addressing this broad set of issues challenging. Questions such as how to reconcile long-term with short-term goals, global expansion with local objectives, and workplace and community issues must be answered without losing sight of the basic goals of profitable operations and increasing shareholder value.

Organizations looking at the broader risk management implications of sustainability are reconsidering their approaches to address intangible and long-term risks as well as more traditional tangible risks. Leading corporations that have implemented formal sustainability programs are embracing these concepts as a part of their overall business strategies and developing new techniques to address emerging risks associated with sustainability issues.

The risk management implication of addressing nontraditional areas is clear: Risk managers must now be able to identify, assess, and address risks they have not been responsible for in the past. To do so, they will need new analytical tools and new responses to address emerging risks. Risk advisors must also develop new resources to meet the needs of their corporate clients as sustainability concepts become embedded in everyday activities.

Importance of Corporate Sustainability to Risk Management

For many corporate executives, sustainability is viewed as a means for survival of the enterprise as well as the planet. This view is strengthened by growing evidence that sustainability can significantly improve corporate performance. The growth in market capitalization of sustainable corporations has outperformed entities with no formal programs by as much as 80 percent over the past six years.

One of the reasons sustainable corporations succeed lies in the shifting balance between tangible and intangible assets within modern business organizations. Historically, the vast majority of a firm's value was represented by physical asset value. Brand recognition, reputation, productivity, innovation, and other intangible factors did not show up anywhere on the balance sheet. Today, that pattern is the reverse for many firms, with intangible assets being regarded as primary determinants of present as well as future corporate value.

Risk managers must be aware that intangible factors associated with sustainability tend to be affected by external pressures from governments, activist groups, investors, and customers. However, many of the risks associated with intangible assets are not fully insurable. This makes sustainability issues significantly more challenging for risk managers, who are being asked to expand the scope of their activities to include emerging risk areas as well as those that have traditionally been insured.

Risk managers may be asked to develop techniques that protect brand value and reputation, neither of which are risks insured by currently available policies. The challenge is to identify and implement alternative risk management strategies to address such risks. When possible, existing policies will have to be expanded or supplemented by new forms of insurance and noninsurance techniques to address the broader risks of sustainability.

Consumer pressure may be the most direct driver of change in business priorities today. Media coverage of global warming, rising energy costs, credit market fluctuations, and product recalls indicate that customers' perceptions have changed substantially. Information, good or bad, is instantly available to the entire customer base and to other stakeholders. To address urgent risks, risk managers must be involved in corporate communications. This may include having plans to counteract bad news through accurate and complete information. Corporations must be prepared to discuss and defend their activities and decisions.

In business-to-business transactions, "customers" are increasingly calling on their suppliers to have a formal sustainability program in place as a condition of doing business with them. For example, Wal-Mart has recently announced a program to measure the amount of energy used to manufacture and distribute some of its products. While it is not clear that the retailer will cut off suppliers that do not measure up to its energy-saving criteria, it is an obvious possibility with this type of initiative. Risk managers must be prepared to advise executives on supply-chain issues and assist in the development of strategies to make certain that the corporation is in compliance with customer requirements that assure continuity of business relationships.

Challenges of Addressing Sustainability

Among the most significant challenges in implementing a sustainability program are the twin imperatives of identifying significant issues and establishing priorities for the deployment of scarce resources. Risks and opportunities of emerging sustainability issues are influenced by long-term trends. These trends include changing demographics, changing climate patterns, emergence of newly industrialized economies, and innovation. Risk management programs must operate over longer time frames than have been customary in the past, and they must have the flexibility to address broader categories of risk. The valuation of corporate (and risk management) performance by a disparate network of stakeholders also adds a new dimension of concern. Risk managers must develop new sources of information and new ways of communicating the results of their work as they respond to these challenges.

The first step is to understand the risks to be managed. A starting point might be to divide all risks into categories such as those risks that are associated with sudden events and those that are more likely to arise out of long-term activities and operations, since each requires a different pattern of response. Catastrophic environmental incidents such as Chernobyl, Bhopal, and the grounding of the Exxon Valdez in Prince William Sound have horrified the world. These events have caused irreparable damage to the environment as well as to the reputations of the firms involved. Sudden events are not restricted to chemical, oil or energy-sector industries. The series of anthrax attacks that took place in the United States in 2001, outbreaks of SARS across Europe and Asia, lead paint in toys, tainted pet food and unexpected large losses in the sub-prime credit market share many of the same characteristics and demand similar risk management responses.

The challenge of embracing areas of risk can be daunting and many firms become overwhelmed in the early phases of the process. Corporations that are making progress start with a broad analysis of risks and quantify the potential impacts to give some order of magnitude to the resources that should be devoted to solving identified problem areas. Recognizing that you cannot do everything at one time, it is better to identify and address a smaller number of issues that really matter than to take on too many tasks and fail at all of them.

After a manageable group of critical risk factors has been identified, action plans can be created to address the prioritized risks. These plans should consider all feasible risk alternatives, from prevention and mitigation to financing and risk transfer. It is often assumed that insurance cannot play a significant role in mitigating emerging sustainability risks. In reality, insurance may be a useful tool in addressing both conventional as well as emerging areas of risk.

Environmental insurance policies have been available to address third-party claims and cleanup costs for releases of pollutants for more than thirty years. However, they have been purchased by few corporations in spite of pollution exclusions in virtually all commercial property and casualty policies over that same period. Environmental policies are being used to develop creative solutions for risks, including legacy liabilities associated with past manufacturing of asbestos-containing products or careless handling and disposal of hazardous wastes. Risk managers have identified other triple bottom line impacts that can be addressed by insurance to help corporations meet their long-term financial, environmental, and social responsibilities. Managers can also protect themselves and their corporations against the risks of immediate loss.

Emergency Response and Corporate Communications

Obviously, the best way to deal with a sudden event is to prevent it from happening. Risk managers and operational teams do a great job conducting the vast majority of their operations and activities in a safe and environmentally sound manner. But they also need to plan for the single catastrophic event that occurs in spite of taking all reasonable precautions. Emergency response and crisis management plans are essential to ensure that the organization is prepared for catastrophic events, rather than simply reacting as they unfold. Even well-designed programs may not be set up to address the interests of the wider stakeholder network.

With the level of scrutiny of corporate responses to events being higher than ever, the implementation and execution of emergency response plans needs to be flawless. Managing the reputational aspects of an incident, and its impact on stakeholders both inside and outside the organization, is crucial to sustaining profitable operations and recovery of pre-incident performance levels. Risk managers must be able to address these new corporate risks with both traditional and nontraditional responses to emergency situations.

There are a number of long-term trends related to sustainability that must be addressed in risk management programs. These emerging risks may not be insurable in currently available property and casualty policies. Some of the most important issues are climate change, worldwide water shortages, the growing demand for energy, environmental management, reputation, and internal and external social issues. Risk managers have many of the skills required to deal with sustainability risks, but they may lack experience in addressing the emerging risks associated with intangible assets and be unfamiliar with some long-term risk strategies that will be required to address sustainability issues.

Organizations that have embraced sustainability view it as an integral part of the business, but the programs have not come about by accident or random unplanned events. The board of directors and senior executives must take responsibility for driving the strategic agenda on sustainability, and it must have at least one champion at strategic levels within the organization that can act at the direction of corporate leaders to implement the sustainability program.

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