Companies need to secure a larger percentage of their cash flow to deal with growing climate risks. Hurricanes, wildfires, and rising sea levels impose costs on businesses in both preparing for and responding to these disasters. These costs will only increase over time as the risks increase.
Risk management can help minimize the costs of climate change. A robust risk management strategy overlays funding tools (insurance, retention and borrowing) to address different aspects of risk. Doing so facilitates recovery by providing businesses with the funds they need when disaster strikes.
But investing in risk management also imposes immediate costs. Insurance premium must be paid in advance. Cash reserves require that you have funds set aside just in case. Planning to finance repairs on credit requires businesses to maintain financial flexibility. You need to be financially flexible so that you can access the loan in the future.
As a result, cash-strapped companies struggle to adjust. Small businesses in particular often operate on thin margins to fund day-to-day expenses such as inventory purchases and payroll. Many people feel that they cannot afford to devote resources to risk management. But without it, businesses may face additional challenges, with higher post-shock recovery costs.
To explore these dynamics, we examined how Hurricane Harvey impacted businesses after it hit southeastern Texas in 2017. Harvey was the most costly event in her 40-year worst disaster year for the United States, causing $125 billion in economic damage. Climate scientists estimate that climate change has made storms about 30% more intense, providing an example of how the risk of severe storms is increasing.
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We explored Harvey’s impact on local businesses using two methods: conducting research and analyzing corporate credit reports.
In August 2018, about a year after Harvey, we surveyed 273 businesses in the affected areas. Virtually from Houston to Corpus Christi on the Gulf Coast. The companies surveyed were similar in age and size to other companies in the region. Our survey asked detailed questions about the losses suffered, how they were paid for, and how the recovery progressed.
To complement our research, we analyzed the credit reports of nearly 5,000 companies in the affected areas and compared that information to 3,000 companies across the United States not included in Harvey’s pathway. While the research provides a broad sense of a company’s experience and recovery strategies, credit reports can help determine whether lenders, landlords, supply chain partners, and others are paying their debts on time. Provides commonly used metrics to assess a company’s financial health.
what the company lost
Our survey asked participants about their loss from Harvey. The company reported various complications, but the most striking was the loss of revenue. Nearly 90% of the companies surveyed reported losing revenue because of Harvey, most commonly in the five-figure range. These revenue losses were due to employee disruptions, declining customer demand, utility outages, and/or problems in his chain of supply.
A small number (around 40%) experienced physical damage to buildings, machinery, and/or inventory. Less commonly, property damage losses were on average more expensive than revenue losses. However, property damage exacerbated the problem of lost revenue by keeping businesses closed: 27% were closed for one month or longer, and 17% were closed for three months or longer. , revenue losses for businesses that suffered property damage nearly doubled.
Post-Harvey corporate credit reports also show signs of distress. Harvey caused many companies to default on their debt payments. In the worst flooded areas, the storms increased delinquent balances by 86% compared to pre-Harvey levels. This impact is primarily limited to short-term delinquency (less than 90 days late). We are not seeing a significant increase in loan defaults or bankruptcies. This pattern may reflect a company’s substantive efforts to avoid default.
How did the company manage loss of revenue and property?
Comprehensive risk management strategies traditionally use insurance to transfer severe risks such as hurricane-related property damage. However, some losses are not covered by insurance, such as reduced demand, employee disruption, and lost revenue due to problems in the supply chain. Borrowing addresses moderate severity losses. Cash reserves cover small losses. This tiering is primarily due to cost. For example, holding large cash reserves increases the opportunity cost. It also requires advance planning and financial vigilance.
This tiered risk management strategy (insurance for big risks, borrowing for moderate risks, cash for small risks) is not what most companies do. Only 15% of the surveyed companies affected by this record-breaking hurricane received insurance. This low insurance coverage is due to the fact that the business is not insured against flood or wind damage (e.g. it had insurance that excludes coverage for these hazards) and/or that the business has insurance on its property. are insured but the revenue exposure is not insured.
Borrowing also played a small role. Twenty-seven percent of the companies surveyed used loans to finance their recovery. After the disaster, companies often did not maintain sufficient financial flexibility to borrow, as half of the companies that applied for new loans were rejected. A low-interest disaster loan from the Small Business Administration is the only federal assistance offered directly to businesses, but businesses did not have the funds to be approved. Overall, only one-third of the surveyed companies that applied for disaster loans were approved.
Similarly, credit bureau data shows how important it is to maintain borrowing capacity in the event of a disaster. Companies with no outstanding debt started borrowing after Harvey. On the other hand, companies with existing debt balances applied for additional credit, but their balances ended up being reduced. This indicates that the bank considered financials too risky.
As a result, companies typically raised funds internally instead of using insurance claims or loans. More than half of affected businesses rely on ongoing earnings or cash reserves to pay for repairs. The business owner and/or the business owner’s family and friends contributed money to keep the business going after Harvey.
What are the long term effects?
Our findings provide a complete picture of companies dealing with large expenses but lacking adequate payment methods. These coping strategies can increase the cost of the event. For example, credit delinquency can ruin a company’s credit report for years.
Additionally, relying on financial support from friends and family can have long-term effects on business success and growth. It erodes the protection of isolation. Existing research concludes that business owners who use informal financing pursue projects that are less risky (and therefore less profitable) than they would otherwise be. Fear of losing friends and family’s money discourages entrepreneurs from investing in the company’s future, leading to slower growth.
The challenges of recovery are evident in the surveyed companies’ responses. 48% had not fully recovered after one year. But risk management appears to improve recovery. In our research, companies with at least one form of risk financing were almost twice as likely to recover as those without.
Lessons for policy makers
Many of the disaster-related challenges are even more acute for businesses with pre-event funding constraints, such as limited access to credit. The impact can be particularly pronounced in minority-owned businesses. Studies show that, in normal times, minority-owned businesses that apply for loans are less likely to get the amount of loan they ask for and are more likely to close after a catastrophe. Funding constraints tend to reduce risk management as available funds are used for immediate needs rather than planning for future uncertain events. Reducing funding constraints has been shown to boost business establishment and growth, and our findings suggest credit expansion policies may make firms more climate resilient. doing.
Our research also provides new insights into why current disaster relief policies, which focus on lending to businesses after losses, are so limited in scope. Many businesses do not maintain the financial flexibility to finance recovery with five or six figure loans after a disaster strikes. We need policies that encourage a wide range of risk-financing tools to help more businesses and their communities recover. Policies that prioritize financial preparedness, such as incentives for emergency savings and insurance, may be particularly valuable.
Lessons learned for business owners
Our results highlight the importance of proactively organizing risk financing. Combining insurance with other sources of funding, such as unused credit or “rainy day” savings, will give you instant access to money in times of need. Prioritizing these buffers can be difficult given all the other financial demands on your business, but having access to cash is essential when disaster strikes. Such buffers are even more important given the challenges posed by the Covid-19 pandemic and ongoing supply chain disruptions.
Establishing a short-term financial buffer is not possible for all companies, but even cash-strapped companies can plan. Proactively planning for disruption can reduce uncertainty when a crisis strikes. For example, you can clarify employee responsibilities for critical functions and develop scenario plans with key vendors. Many companies we surveyed did not have business continuity plans. Those who did so were about 30% more likely to fully recover after Harvey, even if they had no other risk management in place. Small Business Administration provides resources to initiate this type of planning. I’m here.
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Climate risk is increasing the cost of doing business for many companies, making investment in risk management more important than ever. Growing climate threats can be particularly challenging as small businesses face more financial constraints than large ones. Proper risk management can significantly reduce the cost of disasters, but requires financial discipline and careful planning. Insurance can help against some types of loss (such as serious property damage), but in most cases it will not cover loss of revenue. Bridging the insurance gap requires maintaining available debt capacity and building cash reserves.Sustainable recovery in times of crisis depends on having diverse financing tools in place Previous Disaster strikes.
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