Increasing Global Wildfire Threat
In the past few years, the world has experienced drastic changes in wildfire patterns. The increased intensity and higher frequency of wildfires manifested by climate change are evolving into a global trend.
In 2021, all continents with the exception of Antarctica witnessed significant wildfires - Algeria wildfires in Africa; Cyprus, Israel, and Turkey fires in Asia; France, Greece, and Russia fires in Europe; Canada, US, and Mexico fires in North America; Argentine Patagonia wildfires in South America; and Australian bushfires.
According to the European Space Agency, fires affect an estimated 4 million sq km. of earth’s land each year. To put that in perspective, that is almost twice the size of Greenland - a number that is continually increasing, which can be clearly seen when we consider the case of the United States, where the average acreage burnt by the blazes has been growing over the years.
California’s eight largest recorded wildfires by acreage have all occurred since 2017, with 2021’s Dixie Fire recently added to the list.
While a wildfire is a natural part of many ecosystems, various factors are responsible for their increased intensity and risk:
It is one of the most fundamental and significant contributors to the increasing intensity of wildfires globally. Warming from rising greenhouse gas emissions is amplifying various landscapes’ propensity to burn as warmer temperatures propagate dryness and induce drought conditions. Additionally, the fire suppression activities of the past have left forests with dry vegetation that is more prone to catching fire.
Development into the wildland-urban interface (WUI)
WUI is an area where structures are intermingling with fire-prone vegetation. This has further intensified the risk and associated damages of wildfires. According to a study, the number of people living in the WUI in the U.S. roughly doubled from 1990 to 2010. The population in its highest-hazard regions grew by 160%. As more people move into these areas, the opportunity for fires to ignite rises, as does the number of people at risk.
Implications for Businesses
The trend of increased frequency and intensity of wildfires inevitably increases the exposure of businesses to material financial loss across the corporate value chain. Analysing the economic implications of wildfires involves accounting for the cost of damages as well as other indirect costs i.e., costs resulting from power shut-offs, business closures, insurance payouts, supply chain disruptions, real estate valuation changes and much more.
For instance, when we account for the costs of California’s 2018 wildfire season, it amounts to a total of $148.5bn (0.7% of the country’s annual GDP) which includes, the state incurred damages of $102.6bn; indirect losses through economic disruption to 80 industries amounting to $42.7bn; and the indirect losses caused to the U.S. economy amounting to $45.9bn outside California due to economic links between California and the rest of the U.S. Indirect financial losses thereby accounted for 41.5% of the state-wide total damages.
Accordingly, it has become extremely important for businesses to account for wildfire risk in their overall risk assessment.
By enhancing the understanding of firms’ wildfire assessments and risk management practices, wildfire-related disclosure can reduce firms’ uncertainty and users’ risk perceptions, and consequently contribute to higher firm value.
While certain companies such as Marriott and Monster Beverage, have started adding wildfires to their basket of concerns in 10-K filings with the Securities and Exchange Commission (SEC), most firms still fail to include wildfire risk in their risk assessments. According to a 2018 Center for Disaster Philanthropy report, 215 of the world’s 500 largest companies risk losing an estimated one trillion dollars within five years from the impacts of climate events like fires, unless action is taken. This makes consideration of wildfire risk in risk assessment models even more critical!
Mapping the Most Vulnerable Sectors
The implications of wildfires can be observed across all sectors due to the indirect costs of wildfires. However, certain sectors such as Insurance, Electric Utilities, etc. are extremely vulnerable to wildfires.
Risk can be broadly classified into two types -
Systemic - refers to an event that can spark a major collapse in a specific industry or the broader economy.
Non-systemic - imply that the event's implications are restricted to the event itself and can not affect the larger ecosystem.
The fundamentals of the insurance business globally are centred on mitigating the impacts of non-systemic risk. Insurance companies collect a small amount as a periodic premium from a large number of people while insuring them against a particular eventuality. The business model functions on the low probability of the majority of people facing the same eventuality. Hence, the claims can be covered with the collected premiums, distributing the non-systemic risk over a larger group.
However, the increased intensity of wildfires in recent years and their propensity to cover higher acreage has resulted in the conversion of non-systemic risks into systemic risks that can stress entire local economies and—more grimly—cause market failures. This would make claim repayments unfeasible & upend the whole business model for insurers.
The following statistics provide evidence of this phenomenon:
In 2021, the Californian Forest Fires damaged 40 times more homes than in the last 10 years, while insured losses from wildfires in the U.S. exceeded $13 billion.
In December 2021, the rare winter wildfire that burnt two towns in Boulder County, Colorado, while destroying 1,000 homes is estimated to have insured losses of about $1 billion.
In 2019-20, the Insurance Council of Australia estimated the total insurance loss attributed to bushfires nationwide to be $2.3 billion with nearly 39,000 claims. California’s 2017 wildfires resulted in 53,000 insurance claims (residential, commercial, auto, and other), amounting to $12.6 billion in insured losses state-wide. Over 39,000 insured homes were damaged, of which 6,885 were complete losses.
As these wildfires become larger and more frequent, the capacity of insurance companies to cover wildfires becomes more restricted. According to a report from Aon's, there have been "significant" price spikes in excess casualty risks associated with wildfires, "especially when no exclusionary language is in place.” This change is driving various insurance companies to pull out of certain markets. In fact, in January 2022, AIG and Chub decided to pull policies and end coverage for expensive homes in California due to wildfire exposure and regulatory frameworks prevailing in the state.
According to Verisk’s 2019 Wildfire Risk Analysis, 4.5 million U.S. homes are at high or extreme risk of wildfire, with more than 2 million in California. Therefore, there is a heightened need for the insurance sector to monitor and account for wildfire risk in their premium assessments.
Energy and Utility Companies
The energy and utility sector is closely intertwined with wildfires due to the existence of a vicious cycle where the sector causes wildfires and then also gets adversely affected by their occurrence.
Electrical equipment has been a leading proximate cause of some of the most damaging wildfires. For instance, the 2018 Camp Fire in California was one such disaster that destroyed over 150,000 acres, 13,972 residences, 528 commercial structures, and 4,293 other buildings. The 2018 Woolsey fire, which burned nearly 97,000 acres, destroyed more than 1,500 structures and killed 3 people was another such occurrence. It was disclosed that the two fires were caused by PG&E and Southern California Edison respectively.
In fact, 7 of the 10 most destructive wildfires between 2013 and 2018 were caused by power lines!
Electric utility companies are susceptible to financial losses due to wildfire risks because of several reasons.
Firstly, wildfires may cause direct physical damage to utility infrastructures such as power lines and substations.
Secondly, they can be held liable for damages associated with wildfires if their infrastructure is found to be a cause of ignition. This was the case with PG&E which was held liable for causing the California Campfires, resulting in their liabilities surpassing $30bn, causing them to go bankrupt. The bankruptcy of PG&E is widely known as the first climate change bankruptcy.
Lastly, wildfires pose a threat to reliable electricity delivery. In an effort to reduce wildfire risk, utility companies implement preventative blackouts in high-risk conditions that can have severe impacts on health and safety, as well as economic repercussions. For instance, estimates suggest that the PG&E’s preemptive outages in October 2019 — which impacted 800,000 customers, or nearly three million people — cost the economy $2.5 billion. Even Google’s parent company Alphabet added power shut-offs for wildfire prevention to its list of business risks in its latest 10-K filings.
Accordingly, utility companies would require consistent, comparable, reliable, and transparent data to make the electric grid and related assets more intelligent and resilient.
The risk attributable to wildfires for banks is essentially derived from the credit risk associated with their mortgage portfolios. Credit risk is the risk of a financial loss resulting from a borrower’s failure to repay part of or all the interests and the principal of a loan.
On one hand, due to the surmounting physical risks associated with wildfires, banks may face higher loan losses as defaults rise. The European Central Bank’s recent climate stress tests showed that more than 60% of bank loans in Greece, Portugal and Spain are exposed to high physical risk.
“The credit risk channel is what concerns us the most when it comes to the retail banks. And what that means is because of the transition to a new green economy and because of the higher physical risk to the underlying borrowers, the probability of default of the borrowers’ increases,”
**Stefan Nedialkov, director at Citigroup Global Markets.**
On the other hand, as an indirect consequence, banks may face the impact of a feedback loop set in motion due to wildfires as the value of assets declines, reducing their collateral value.
According to a report by the climate on the effects of climate change on Australia’s economy, climate change and extreme weather are projected to reduce property values by $571 billion by 2030, $611 billion by 2050 and $770 billion by 2100.
Owing to this dual nature of risk for the banking industry, it becomes critical for banks to account for wildfire risk in their credit portfolios and manage their lending accordingly.
Global Supply Chains
Much of the economic activity around the world is composed of a complex system of interdependent supply chains. End products have several parts sourced from diverse geographies around the world. Disruptions to these supply chains may create a ripple effect in industries across the globe.
Wildfires pose a severe threat to these supply chains. This can be observed in wildfire-prone areas like Australia, Canada and America West.
“It’s obvious that the impacts of climate change that we’re already experiencing today, wildfires, drought, extreme weather, more intense hurricanes, crop yield declines, water shortage and the political disruption that comes from the forced migration and political instability it generates — these are enormous stress to many supply chains of companies and not just companies that are making physical products but in finance and services,” said John Sterman, professor of management at MIT’s Sloan School of Management and co-director of Sloan’s sustainability initiative.
For instance, about a quarter of the lumber consumed in the U.S. comes from Canada. However, due to wildfire and drought conditions in Canada in 2021, lumber producers are experiencing difficulty in transporting lumbar to the markets, in turn leading to a disruption in the building material supply chain.
The intensity of these losses and the ripple effect they generate across sectors makes it pivotal for businesses to integrate wildfire data in their risk assessment models. This would allow them to quantitatively analyze their supply chains and predict and prepare for any possible disruptions.
Mitigating the Risk
“Managing the risks posed by wildfires can be somewhat different from other natural hazards because actions on the part of business owners and government entities can reduce the hazard, vulnerability and risk.” - Clifford Oliver, Former FEMA senior official and principal at Nanticoke Global Strategies
There’s an age-old prose that you can’t manage what you can’t measure, which stands true in the case of wildfire risk mitigation. There is a need for reliable monitoring infrastructure for organisations and government stakeholders to factor wildfire risks into their risk assessments.
However, due to the unpredictable nature of wildfires, developing a monitoring infrastructure has traditionally been a mammoth task. Traditional methods like IoT monitors, cameras etc. are expensive and time-consuming. For instance, companies like Sempra Energy’s San Diego Gas & Electric rely on a network of cameras to live-stream fire-prone areas. However, this apparatus results in rudimentary and fragmented data that only allows them to monitor a limited area.
Geospatial data can address this shortcoming. As a result of technological advancements, combined with a significant number of satellite launches, it is now possible to monitor extensive areas in real-time and gathers insights like never before. Thus, it is a perfect tool for developing a standard monitoring infrastructure that can equip organisations in various sectors with decision-useful data.
While geospatial data is a great solution, obtaining valuable insights in its raw form is tedious, expensive, and time-consuming. An effective wildfire monitoring infrastructure that can deliver various key parameters like historical and predictive burnt area mapping; wildfire risk accounting for the probability of ignition, biophysical influences and topography; emissions attributable to wildfires etc., would need to process and analyse vast volumes of earth observation satellite data. This points towards the need for organisations with analytical skills and computational capacity to integrate data from various sources, like satellites, ground measurement monitors, clean, optimise, and normalise the data, and then build multiple types and levels of analytical models. Further, disseminating this data both via easily integrable APIs for more extensive usage and adoption and via a simpler visualisation platform for any layperson is critical.
Let’s fight fires together!
The advent of climate change and its increased tendency to manifest extreme heat events has exacerbated their economic consequences globally. The dire need to tackle these challenges requires fundamental transformations to business models and deep integration of climate risk, specifically wildfire risk, into the overall risk assessment framework.
A standard monitoring infrastructure would play an instrumental role in this respect and would help businesses not only preempt wildfires but also deploy resources efficiently. Together with data and decision-useful insights, businesses worldwide can become more resilient.