Risk Assessment and Risk Management for Infrastructure Planning and Investment

Managing risks associated with climate change is essential for planning and policy decisions.

In Climate Change 2007: Impacts, Adaptation and Vulnerability, the contribution of Working Group II to the Fourth Assessment Report (AR4) of the Intergovernmental Panel on Climate Change (IPCC, 2007a), authors from around the world focused attention on the impacts of climate change that we either cannot avoid or choose not to avoid. In other words, IPCC made the case that adaptation to climate change should no longer be considered as giving up on the problem. This message is reinforced in the panel report on adaptation to climate change released in May by the National Research Council (NRC, 2010a).

Many impacts of climate change become apparent through increasingly intense and/or more frequent extreme weather events (e.g., heavier precipitation, more intense coastal storms, and severe droughts, floods, wildfires, and heat waves). Both the IPPC and NRC reports describe changes attributed to anthropogenic sources that have already been observed and are threatening some unique social and natural systems. The magnitude of these changes will very likely be exacerbated over the near and more distant future as natural climate variability is distributed around increasingly worrisome central tendencies. Indeed, because temperature increases driven by higher greenhouse-gas concentrations reflect only 50 percent of the corresponding equilibrium warming, near-term decisions to mitigate climate change modestly (or not at all) may actually commit the planet to sudden, irreversible changes by the end of the century (NRC, 2010d; Solomon et al., 2009).

Given the evidence, climate is changing, and absent significant reductions in emissions of greenhouse gases, it will continue to do so at an accelerating pace. IPCC, its client governments, the New York Panel on Climate Change (NPCC, 2010b), the National Academies (NRC, 2010a,b,c,d), and many other international assessments have all turned to risk management as a framework for constructing responses to climate challenges. Indeed, the unanimously approved “Summary for Policymakers” in the IPCC Synthesis Report closed with a statement on the importance of considering risk in all deliberations: “Responding to climate change involves an iterative risk management process that includes both adaptation and mitigation and takes into account climate change damages, co-benefits, sustainability, equity and attitudes to risk” (IPCC, 2007b, emphasis added).

Governments throughout the world have thereby clearly stated their understanding that managing risks associated with climate change must be the central theme in present and future planning and policy decisions. Moreover, now that all four NRC panels of the America’s Climate Choices initiative have accepted this tenet, we can count the United States among those governments.

This article begins by covering some critical definitions and fundamental insights about applying the risk-management paradigm to climate adaptation and mitigation and a brief description of a specific application for infrastructure investment in urban Boston designed explicitly to respond to potential changes in climate driven by natural cycles. This is followed by a description of New York City’s decision to include climate change in its planning processes to protect both public and private infrastructure. The article ends with some observations about the context and applicability of risk management approaches to adaptations to climate change.

Definitions and Fundamentals

Our understanding of some of the aspects of climate change is well established. For example, IPCC (2007b) concluded that it is “virtually certain” that global mean temperatures are rising, and NRC (2010a) confirmed this conclusion. Both assessments also concluded that we know with “very high confidence” that anthropogenic emissions are the cause of this temperature rise.

Thus, even though substantial uncertainties persist about specific sources of risk from specific manifestations of climate change at specific locations, IPCC and NRC agree that near-term action, including adaptation, should be taken immediately to minimize the costs of reducing the rate and magnitude of climate change impacts driven largely by increases in global mean temperature. This means that local decision makers must take action in the face of substantial uncertainties and associated risks, particularly when making decisions about major investments in infrastructure.

All risk management techniques are based on the same statistical definition of risk—the probability that an event will occur multiplied by a measure of its consequences (e.g., Raiffa and Schlaiffer, 2000). Many decision makers favor risk-based approaches because they are based on the same theoretical underpinnings that support other kinds of economic analyses and because they can be applied to situations characterized by significant uncertainty.

Finance directors, government officials, and infrastructure managers, all of whom deal with risk and associated best practices on a daily basis, understand that spreading risk can improve social and/or private welfare. Even though risk diversification does not eliminate risk in most cases, spreading risk does lower net exposure for all participants.

On a fundamental level, first principles of economic efficiency in an uncertain world lead to robust responses that work reasonably well for a wide range of possible outcomes even though they may not be optimal for any particular outcome.2 Because uncertainty is inherent in our understanding of climate change and climate impacts, particularly impacts driven by changes in the distributions of climate variability, it is entirely appropriate that risk has become the “currency of the realm.”

Take, for example, a recent analysis of a large public investment to provide substantial protection along a developed coastline in an urban area of Boston; the area is subject to future coastal storms whose intensities will be amplified by sea level rise (Yohe et al., forthcoming). Figure 1 shows distributions of underlying damages that could be suffered for selected times for a 1.0 meter sea level rise by the end of the century.

Decisions about whether and when to make this investment (and thereby commit to ongoing maintenance expenditures that will last for decades) involved determining when the present value of benefits (i.e., reductions in damages calibrated to include attitudes toward risk) would exceed the present costs. Specifically, the analysis confirmed that damages attributed to sea level rise—the source of value for this adaptation—would increase as risk aversion increased. This is illustrated in Figure 2, which shows the internal rates of return (IRRs) for undertaking the Boston investment at various times between now and 2040 as aversion to risk increases.

To understand Figure 2, relative risk aversion (RRA) must be set at 0 to indicate complete risk neutrality. In other words, RRA = 0 means that decision makers are agreed that a dollar of damage is the same regardless of whether it is the result of a catastrophically large storm or an unusually small storm that might be inconsequential from a societal perspective. Allowing the RRA value to rise above zero indicates that decision makers feel that the consequences of coastal storms increase with their intensities, and at an increasing rate (because simple dollar metrics do not reflect the magnitude of social disruption and human pain caused by larger storms).

For reference, the IRR of an investment indicates the discount rate for which the present value of net benefits is zero. Investments may be made with IRR values greater than the going rate of interest (i.e., the rate by which decision makers discount future costs and benefits), but investments with IRR values below the applicable interest rate are either deferred or discarded entirely.

Therefore, because the IRR increases with risk aversion, investments that reduce risk become increasingly appealing as decision makers become increasingly averse to risk. Because the IRR increases over time, the adaptation investment has a predictably greater chance of being above the implementation threshold with the passage of time.

Several general hypotheses can be derived from this analysis for cases in which the manifestations of climate change cause economic damage stochastically correlated with long-term trends. First, the choice of a baseline against which to gauge the values of various responses to external stress is not just an academic exercise. Differences in baselines, which can be framed in terms of the degree to which economic risk can be spread across a population, and therefore the degree to which RRA approaches zero, can easily change the value of an adaptation and influence its optimal timing.

Second, the economic value of an adaptation should be expressed in terms of differences in expected outcomes (damages with and without the adaptation) only if the affected community has access to efficient risk-spreading mechanisms or reflects risk neutrality in its decision making procedures. Otherwise, increases in decision makers’ aversion to risk will increase the economic value of adaptations that reduce expected damages and diminish the variance of their inter-annual variability.

Finally, for engineering and other adaptations that involve significant up-front expenses followed by annual operational costs for the foreseeable future, increases in decision makers’ aversion will increase the value of that adaptation and, therefore, move the date of economically efficient implementation closer to the present.

The New York City Approach to Adapting Infrastructure

Although in theory a risk-based approach can be applied to many types of adaptation decisions (e.g., retrofitting existing infrastructure, changing the design of new infrastructure, or initiating new infrastructure projects), the requisite data may not always be available. Thus the need to identify information requirements and gaps in knowledge is one reason to begin planning for and prioritizing adaptation options as soon as possible.

New York City adopted a risk-based approach of the kind described above to protect its enormous private and public infrastructure from increasing vulnerability to climate change and associated climate variability. The city was motivated by abstract, sometimes academic constructions of risk which were turned into practical, transferable decision-support tools that could be applied in situations where information was scarce.

From the beginning, the research and policy communities understood that setting climate policy for an entire century would not be possible. For example, based on our current understanding of climate sensitivity, the likely range of temperature rise is from 2oC to more than 4.5oC, but it could also be much higher (IPCC, 2007b). In addition, it is now widely accepted that even advances in fundamental scientific understanding are not likely to lead to substantial decreases in this temperature range.3 Roe and Baker (2007) showed, for example, that “the probability of large temperature increases” is “relatively insensitive to decreases in uncertainties associated with the underlying climate processes.” Allen and Frame (2007) further argued that it is pointless for policy makers to count on narrowing this fundamental uncertainty.

Thus decision makers and resource managers must accept that inflexible, long-term, climate-change policies that can predictably limit greenhouse gas emissions and associated risks will not be put into place in the near future. Therefore, there must be a process by which interim targets and objectives for both mitigation and adaptation can be informed by long-term goals to enable appropriate adjustments to be made as efficiently and transparently as possible (Yohe et al., 2004).

Although this simple conclusion makes sense, problems arise as soon as one begins thinking about how to make it operational, especially for infrastructure investments with lifetimes that can last for many decades or longer. Figure 3 is a schematic portrait of one approach showing a threshold level of acceptable risk (represented by a horizontal wave) that would be breached around 2035 if climate change continues unabated. Incremental adaptation alone, reflected by a “saw-toothed” trajectory, would involve a sequence of responses for keeping risk below the acceptable limit. Since this trajectory approaches the threshold of tolerable risk more quickly and more frequently with the passage of time, Figure 3 illustrates why IPCC (2007a,b) concluded that unabated climate change could easily overwhelm the capacity to adapt by 2100 even in developed countries.

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Publisher and/or Author and/or Managing Editor:__Andres Agostini ─ @Futuretronium at Twitter! Futuretronium Book at http://3.ly/rECc