Insights

Why Climate Change Belongs on Your Financial Report

September 13, 2020

With fiscal year 2020 ending September 30, many federal agencies are well on their way to developing FY20 financial reports. These reports lend insight into an organization’s performance and priorities as well as how it plans to allocate resources to meet future challenges.

Extreme-weather events are an underreported challenge that poses considerable fiscal risk to agencies’ assets and operations. Despite advancements in calculating these risks, federal standards have not adapted to accommodate this type of reporting. The Federal Accounting Standards Advisory Board is examining this issue and recently provided a training course on federal accounting for climate-related events.  Here are a few reasons why disclosure of climate-related risk is integral to an agency’s financial reporting.

Climate-related risk is inescapable.

Climate-related risk is not confined to coastal, hurricane-prone areas; federal infrastructure and operations around the world must contend with challenges unique to their location. These include acute, destructive threats like flooding and wildfires as well as chronic conditions such as sea-level rise and extreme temperatures, which can degrade and depreciate assets over time. This cumulative risk has grown dramatically. The number of extreme-weather events in the U.S. to cause at least $1 billion in damage and loss per year, adjusted for inflation, has quadrupled since the 1980s, according to the National Oceanic and Atmospheric Administration (NOAA). The U.S. is averaging one billion-dollar disaster per month in 2020, a pace that NOAA data indicates may become the norm for the next decade. Simply put, no assessment of an agency’s overall fiscal risk is complete without a discussion of climate-related concerns.

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The government’s risk exposure is twofold.

The federal government has immense portfolios of property and infrastructure. Funding for climate adaptation and resiliency of these assets and associated recovery and reconstruction is significant. The Department of Defense alone owns and operates domestic and overseas infrastructure with an estimated replacement value of $1 trillion, according to a March 2019 U.S. Government Accountability Office report. The fundamental risk to federal agencies as property owners is not too different from the private sector.

However, the federal government also incurs extraordinary cost as a primary furnisher of emergency relief operations. Not only do extreme-weather events require significant manpower and financial assistance; those resources are often diverted from other public services, and federal programs may incur significant debt as a result. A full disclosure of climate-related risk can help agencies better understand the direct costs as well as secondary impacts to mission operations.

Quantitative data enables action.

Analyzing climate-related risk in financial reporting enables agencies to quantify the costs and thereby become better informed about the cost-effectiveness of different mitigation strategies. These steps could include climate adaptation—hardening assets against extreme-weather events, disposing risky assets, and reserving funds for future resiliency-minded improvements. Federal grant spending on hazard mitigation over the past 23 years yielded a benefit of $6 for every $1 invested, according to a December 2019 study by the National Institute of Building Sciences. Equipped with quantitative data, agency leaders can justify investments that strengthen protection of vital assets while offering significant long-term cost savings.

Climate risk analysis has never been more accurate.

Historically, articulating exposure to climate-related risk in finite terms has been difficult; how do you account for the possibility of “a hundred-year flood” over two or three budgeting cycles? This may explain why climate risks were not more readily included in financial reporting sooner. Yet new analytic tools and methods have brought greater precision to the practice, translating an immense body of climate science and projection scenarios into quantifiable, asset-level, and decision-useful results. Organizations specialize in these analyses. (The Climate Service, an LMI partner, was recognized as a leader in climate risk analytics in The Forrester New Wave™: Climate Risk Analytics, Q3 2020 report.) Moreover, advisory and governance bodies offer additional resources; recommendations by the Task Force on Climate-Related Financial Disclosures have been embraced by nearly 1,000 companies.

Climate-related risk is a growing source of fiscal uncertainty for federal agencies. By disclosing these risks in annual financial reports, agencies are better positioned to support climate adaptation strategies that minimize costs and limit mission disruption over time. Learn more about how LMI and The Climate Service help federal agencies plan for and mitigate climate-related risks.

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