Climate mitigation efforts in cities with high risks of flooding will pay less in bond and insurance premiums if measures are taken to curb such activity.
That’s according to a recent paper by Anya Nakhmurina, assistant professor of accounting at Yale School of Management and Shirley Lu, assistant professor at Harvard Business School’s accounting and management unit. The two researchers presented their findings at the annual Municipal Finance Conference hosted by the Brookings Institution.
“Cities with flood risk priced into muni bonds showed that flood risk premium is attenuated when we control for adaptation measures,” Nakhmurina said.
The study set out to “construct new time-varying measures of city-level climate adaptation from cities’ budgets, annual reports, and bond prospectuses,” the paper said. “We validate our adaptation measures by showing that they are associated with charges to capital and emergency funds, a lower flood risk insurance premium and a reduction in climate risk premium in municipal bonds.”
Climate adaptation measures can be grouped into two categories. One is hard adaptation, or projects undertaken to reduce flood risk such as sea walls, flood control dykes and flood walls. The other is soft adaptation, which includes nature and sediment based solutions such as beach nourishment and mangrove restoration.
There is a high correlation between cities with significant flood risks and adaptation efforts.
“We find that adaptation is higher in cities with higher flood risks and that adaptation increases after major hurricanes,” the paper said.
While adaptation efforts are stronger in places that require it, whether the city is positioned within a red or blue state may have some influence on future adaptation efforts.
“There’s a high association between the beliefs of the citizenry and the extent of adaptation efforts as ordered by the city,” Nakhmurina said. But that’s not the only consideration that could limit these efforts.
“Holding flood risk constant, we find adaptation is lower in cities with Republican mayors, cities with capital constraints and with a shorter planning horizon,” the study found. “Cross sectional analyses show that financial constraints are mitigated by the availability of state grants, while political and planning horizon constraints are mitigated when residents are more concerned about climate change.”
But while some of these risks are being priced into bond prices and insurance premiums, it is still very challenging for many cities to look at environmental challenges and develop a battle plan.
“It’s very challenging to apply some of these scientific concepts down to specific boundaries in a consistent and comparable manner,” said Alexa Gordon, portfolio manager and head of muni ESG at Goldman Sachs.
The narrow scope of the study, which looked at coastal cities with greater than 150,000 residents, doesn’t necessarily prepare much of the country for further environmental hurdles.
“I would urge the authors to look beyond the flood risk,” Gordon said. “There are many other acute physical risks, whether it’s wildfire, water stress, or droughts, and then thinking about some of the chronic risks, like temperature rise or loss of biodiversity, that could really be analyzed in future versions.”
But Gordon praised the efforts of the authors to build a systemic approach for measuring impacts and for building a dictionary of terms in the paper that market participants can use for further analysis.