We provide transparency on our approach to assessing creditworthiness through our published methodologies. In addition, in "Environmental, Social, And Governance Principles In Credit Ratings," published Oct. 10, 2021, we explain how environmental, social, and governance credit factors are incorporated into the credit ratings analysis, which we do by applying our sector-specific criteria when we think these factors are, or may be, relevant and material to our credit ratings.

Why this matters:   In 2023, as of Sept. 30, environmental and social factors drove 113 rating actions across the sectors that we rate, or about 5% of total rating actions. Among these, we've observed positive rating actions on corporate entities returning to credit stability after recovering from COVID-19 headwinds, which were underscored by the health and safety social factor. Some negative rating actions were driven by extreme weather, such as the super typhoon that hit Guam and the devastating wildfire in Maui, reflecting an environmental physical risk factor. Further, in many cases, environmental and social factors may not directly lead to a rating action, but our credit rating analysis may be influenced by these credit risks or opportunities. Across all of the corporate sectors we rate globally, climate transition and physical risks accounted for important considerations in the credit analysis of more than one-quarter of our ratings.

What we think and why:   Our sector-specific criteria have long embedded credit risks and opportunities stemming from environmental and social factors into our analysis. We have observed that environmental and social factors could affect entities across multiple areas of our credit rating analysis (see chart 1). We do not separately consider these credit risks from an entity's credit fundamentals and may analyze the materiality of them through peer comparisons, scenario analysis, and relevant sector- and entity-level data.

Chart 1 

How Credit Ratings Could Remain Stable Amid Environmental And Social Risks

Changes in the regulatory environment, consumer preferences, and demographic trends could lead to credit risks and may overlap with environmental and social factors. But the degree of influence these factors have on our credit analysis of an individual entity could be informed by stress testing, assessing downside scenarios from our base case, and benchmarking an entity's exposure and preparedness against peers using data we collect on industry norms.

Environmental and social credit factors can emerge asymmetrically across sectors, industries, geographies, and entities. In addition, given the growing frequency and severity of climate-related risks, we believe such events can weigh on the credit quality of some entities more than others. Therefore, we analyze these risks against an entity's comprehensive risk management strategies, financial liquidity and reserves, as well as planning and adaptation efforts that could help preserve credit quality, at least in the near term.

Chart 2 

The following examples demonstrate observations on how environmental and social risks may influence our analysis in the sectors we rate. These risks may be offset by other aspects of an entity's credit fundamentals, reducing the extent to which these risks, in and of themselves, influence the rating outcome.

Physical risk regarding governments

Environmental and social credit factors can influence a government's capacity to serve its population, respond to changing service levels and demands, or ensure resilience from the acute and chronic physical impacts of climate hazards. These may influence credit rating outcomes by affecting long-term fiscal sustainability, economic development efforts, and the ability to implement revenue enhancements when necessary.

Sovereigns

Physical risks currently pose a limited direct threat to our sovereign ratings on advanced economies, since advanced economies with exposure to natural catastrophes also tend to have solid adaptation strategies, resilience records, and infrastructure. Our ratings on many emerging-market sovereigns, on the other hand, are more likely to reflect potential risks arising from future natural disasters.

For example, our economic assessment for sovereigns includes a potential negative adjustment for volatility in economic output. This often applies to developing countries that face persistent exposure to natural disasters or adverse weather conditions and that lack economic diversification or mitigation strategies to absorb these losses. When natural disasters hit, they may also affect our fiscal assessment (through the impact on tax revenue and spending pressures) and our external assessment (through a sudden loss of exports) as damage costs rise.

Australia (AAA/Stable) is one example where the severity and frequency of declared catastrophes has trended upward over the past 12 years. The largest bubble in chart 3, which depicts insurance claims paid in the three years ended December 2022, captured Australia's worst three years for catastrophe claims since the series began, with total claims of about A$12.7 billion. The 2022 floods that affected southeast Queensland and New South Wales were the costliest insured event on record for Australia, with the claims totaling more than A$5.6 billion. (For more information on Australia's credit rating see "Australia 'AAA/A-1+' Ratings Affirmed; Outlook Stable," published Sept. 20, 2023).

Chart 3

U.S. states and local governments

Generally, our credit ratings on U.S. states reflect highly experienced management teams that regularly balance competing priorities when allocating financial resources. Management teams typically undertake long-term plans and preparations, assess vulnerability, and maintain insurance coverage. These measures, together with substantial economies, broad and diverse employment, and revenue raising flexibility that underscore strong credit fundamentals, help reduce the degree to which acute and chronic physical risk affect the credit rating analysis, even though government entities in the U.S. are generally responsible for providing the initial emergency response. Still, U.S. governments may experience financial and economic consequences following the immediate aftermath of an acute climate hazard such as wildfires, floods, or hurricanes.

Long-term risk around government financials

Despite the rising risk of fire, rain, and riverine floods across Australia, we think the strong balance sheet will help it remain the ultimate backstop in recovery. The Australian government typically reimburses subnational governments 50%-75% of the costs to reinstate vital infrastructure under the legislated Disaster Recovery Funding Arrangements (DRFA) and its predecessor, the Natural Disaster Relief and Recovery Arrangements (NDRRA). The 50% reimbursement rate kicks in once disaster spending exceeds a threshold of just 0.225% of state revenues, and the 75% reimbursement rate activates at 1.75x the first threshold, or about 0.4% of state revenues (see chart 4).

Australia's process is similar to the safety net provided by the Federal Emergency Management Agency (FEMA) in the U.S., which reimburses governments following natural disaster declarations, sometimes up to 90% of the initial cleanup and recovery costs (see chart 5). In addition, U.S. states that face greater exposure to physical risks, typically employ robust risk management practices, including a consolidated emergency response and a long-term view of infrastructure and resource resiliency.

For example, Texas (AAA/Stable) regularly reviews its water sufficiency plan in the face of more frequent drought condition and population growth. It also is planning a referendum in November 2023 to direct funding to dedicated accounts for enhanced water supply and infrastructure, if approved by voters. (For more information on Texas' credit rating see our summary analysis, published Oct. 10, 2023).

Chart 4

Chart 5

Of course, if the cost of disasters grows more quickly than what governments can absorb (either by raising revenue or cutting other expenditures), it could affect credit quality at all levels of government. Sovereigns may need to absorb increasing costs of recovery and resilience, and intergovernmental risk-sharing arrangements could shift to place more of the financial burden of risk-mitigation on local governments.

For example, under a stress test scenario, we indicated that our 'AAA' credit rating on Australia could come under pressure if natural disasters are several times more damaging than those in 2021-2022 and occur over multiple years (see “Bigger Flood And Fire Tests Lie Ahead For Australia,” published Jan. 16, 2023, on RatingsDirect). Subsequent developments in Australia have reflected additional rating headroom than at the time of the January stress scenario (see "Inflation, Jobs, Spending Restraint Narrow Australia's Deficit," published May 9, 2023, on RatingsDirect). Nonetheless, physical risks in Australia and costs are likely to rise indicating that its financial strength and generally swift and decisive policymaking remain key aspects of its preparedness.

In addition, if FEMA discontinues its usual practice of providing financial support to U.S. governments for response and recovery efforts following severe weather events, we believe state and local governments may need to absorb these costs. For example, for the last 30 years, FEMA spending was, on average, $12 billion annually. While some U.S. states can incorporate $12 billion into their annual budget, it could crowd out other obligations, such as pension and other postemployment benefit contributions, health care benefit costs, or debt service payments.

Health and safety regarding U.S. ports

At the pandemic's onset in March 2020, many transportation infrastructure enterprises, including maritime ports that we rate, shut down. Total U.S. port volume declined in second-quarter 2020 compared with the same period in 2019. However, the decline was temporary, and volumes began increasing in the third quarter with 2021 twenty-foot equivalents (TEUs) reaching their highest levels (see chart 6).

Chart 6

Although supply chain disruptions and port congestion slowed the arrival and distribution of containerized goods, this sector generally benefited more than any other U.S. municipal transportation sector during the height of the pandemic in 2020 and 2021. Looking ahead, slowing global economic activity and higher fuel prices could reduce volumes and increase operating costs, but we believe port operators will manage the effects. Activity levels at ports during the pandemic helped bolster balance sheets and reserves, positioning them to absorb potential future operating shocks including those from environmental and social factors.

The Influence Of Risk Could Be Rising Faster Than Preparedness

Our credit ratings or outlooks may evolve from policy, legal, or regulatory changes that impose new or higher costs on the obligor, such as carbon taxes to incentivize the reduction in greenhouse gas emissions. The tipping point for a change that leads to a change in credit rating, revision of the outlook, or a CreditWatch placement may be influenced by the amount of headroom, if any, within the credit ratings on the obligor or issue. This headroom provides capacity for some of the credit factors, which are embedded in the rating, to change without the credit rating or outlook changing, when applicable. Headroom can change over time.

Chart 7 

Climate transition risk regarding corporates and infrastructure

Europe and China's target to reach net-zero emissions and the U.S.'s decision to rejoin the Paris Agreement reflect secular changes that could affect growth and profit margins for entities that produce heavy greenhouse gas emissions. This includes those in the transportation, midstream, and oil and gas exploration and production sectors. Our analysis of competitive risk and growth for each industry is a prospective analysis and is one of the ways we capture long-term trends and uncertainties in our ratings. Typically, climate transition risks for corporate entities can be classified around four pillars.

Chart 8 

At this time, we view regulatory and policy risk as the most relevant to a company's credit profile. This reflects our view that technology and consumer behavior may take longer to evolve at a scale that disrupts a whole sector, whereas regulation can quickly change the landscape, depending upon implementation timing, potential financial penalties, and reputational risks for lack of compliance.

Below, we highlight examples of recent rating actions in the corporate and infrastructure sectors that were primarily based on changing regulatory and policy conditions within certain countries. (See related research for additional information on each rating action.)

Dutch airport Royal Schiphol Group N.V.   We lowered the ratings to A-/Stable/A-2 from A/Negative/A-1 in July after the Dutch government announced its intention to reduce annual aircraft movements to 440,000 from 500,000. We now see a heightened risk of environmental policy objectives potentially hampering Schiphol's operations in the longer term. As the Netherlands strives to reach its goal of sharply cutting national emissions to 49% of 1990 emissions by 2030, Schiphol is exposed to increasing government intervention or regulations that directly effect its credit profile. (We subsequently upgraded the airport operator to A/Stable/A-1 based on strong deleveraging.)

China-based automotive supplier Geely Automobile Holdings Ltd.  We revised our outlook on the 'BBB-' long-term issuer rating to negative from stable on Nov. 21, 2022. We believe the issuer's push for higher electric vehicle (EV) production is weighing heavily on its profitability and leverage. Its accelerated electrification processes to mitigate energy transition risk have led to higher capital spending. Also, small sales and production volumes and high battery costs (up at least 20%-30% in the first nine months of 2022 in China) have seen EVs generate notably lower margins than the group's internal combustion engine (ICE) models.

Chilean power producers Enel Chile S.A. and Inversiones Latin America Power Limitada (ILAP).  We downgraded Enel Chile to 'BBB' on Jan. 24, 2022, and ILAP to 'BB-' on June 24, 2022, due to intense drought lowering hydroelectric generation and eroding domestic electricity market conditions. This also triggered higher-than-expected investments for Enel Chile to prioritize carbon reduction and accelerate its energy transition.

Physical risk regarding insurance

Physical risks, such as wildfires, floods, hurricanes, rising sea levels, and increased temperatures have brought increased claims for insurers. This can be a significant source of risk for reinsurers that write predominantly property and casualty (P/C) risks. In 2022, global natural disasters resulted in $132 billion in insured losses, marking it as the fifth costliest year on record. Since 2020, global weather-related insured losses exceeded $100 billion annually, highlighting a generally upward trend.

Chart 9

We typically reflect significant concentrations or accumulations of natural catastrophes in our assessment of an insurer's risk exposure. Property insurance and reinsurance serves an important role in building economic and financial resilience for loss-affected policyholders after a loss event. However, as issuers increasingly concentrate their exposure to physical risks, we believe these aggregations raise the potential for volatility in their earnings and capital, which is a negative consideration in our assessment of their creditworthiness.

The following rating actions represent the financial impact insurers operating in high-risk regions will continue facing from catastrophe risks in homeowners' business lines, which could further erode earnings and, ultimately, capitalization. (See related research for additional information on each rating action.)

Allstate Corp.   On Aug. 11, 2023, we lowered our long-term issuer credit rating on Allstate's holding company to 'BBB+' from 'A-', and the issuer credit and financial strength ratings on the core operating subsidiaries to 'A+' from 'AA-'. The downgrade reflects Allstate's continued weak underwriting performance amid elevated catastrophe losses. The losses primarily resulted from the increased frequency and severity of physical risks, persistently high loss costs in the personal auto business, and increased exposure--measured by premiums--consuming higher levels of capital. The year-to-date property-liability catastrophe losses were $4.4 billion, up from $3.1 billion for the full year of 2022.

American Family Mutual Insurance Co. S.I.   We lowered the rating to 'A-' from 'A' on Aug. 25, 2022. This reflects how elevated weather losses combined with inflationary challenges in home and auto affect some insurance companies. A severe convective storm in the Midwest in the first half of 2022 hurt American Family Mutual, and it remained exposed to Atlantic hurricane losses and California's wildfires in the fourth quarter of 2022.

Liberty Mutual Group Inc.   We revised the outlook on the rating on to negative on Aug. 17, 2023, reflecting a significant uptick in weather-related natural catastrophe losses during the first half of 2023 ($3.3 billion, up from $1.8 billion in the prior period in 2022). In addition, unfavorable capital market conditions undermined underwriting margin and further strained capital adequacy.

Human capital regarding corporate and not-for-profit health care

The health care services sector is labor-intensive and relies on skilled medical professionals. Physical, emotional, and mental demands of a multiyear pandemic weighed on health care professionals, causing significant attrition. To manage the impact, health care services providers bolstered wages or resorted to temporary, high-cost contract labor. The sector also adopted innovative techniques, such as relying less on doctors and more on physicians' assistants and nurse practitioners. The related costs reduced profit margins for some health care providers, while contract labor rates climbed alongside the demand for employees, affecting revenue growth or debt service coverage requirements.

Chart 10

From 2021-2023, year to date, S&P Global Ratings took 15 rating actions on U.S. not-for-profit health care entities due to human capital financial pressures. In these instances, the rating actions directly resulted from reduced balance sheet strength, declining debt service coverage, and thin operating margins attributed to higher costs--particularly agency nursing expenditure, as systems and facilities filled staffing gaps with more expensive contract labor.

The labor challenges may have peaked, with some easing shown in data from the U.S. Bureau of Labor Statistics and commentary from hospital executives in recent quarterly earnings announcements. Still, employee figures for nursing and residential care facilities are lower than the pre-pandemic levels. Nevertheless, costs remain elevated and the labor market remains tight; employing and retaining nurses remain top concerns for health care managers.

Chart 11

Health and safety regarding airports

At the onset of the pandemic, global travel restrictions were one method that policymakers implemented to curtail the spread of COVID-19. As a result, the airport sector experienced a dramatic and rapid decline in activity. While previous shocks to the sector, like the 9/11 terrorist attacks, are embedded into our industry risk analysis, the uncertain duration of the pandemic and its global impact was unprecedented.

Our rating actions in the airport sector during the pandemic reflect principles one, three, and four in our ESG criteria.

Chart 12 

Moreover, the sector has experienced an uneven recovery. Although North American markets led the recovery, other regions have lagged, employing a more cautious approach in opening and dampening regional air traffic. In fact, we expect 2023 will be the first post-pandemic year that is almost free of mobility restrictions related to COVID-19, as China reopened at the beginning of the year.

Chart 13

The sector evolved as airports and airlines implemented safety measures to reduce public health risks. However, the industry may be fundamentally changed from the experience; following the pandemic, we think aviation-related sectors could be more vulnerable to credit rating deterioration following a significant health and safety event. According to the International Air Transport Association (IATA), an airline trade body, international connectivity currently remains about 87% of 2019 levels in Europe and North America. Further, the IATA does not expect a full recovery industrywide until 2024, demonstrating nearly four years of varying operating and financial pressures after the pandemic's onset.

Related Research

• ESG In Credit Ratings October 2023 , Oct. 19, 2023
• Allstate Corp. And Core Subsidiaries Downgraded On Weaker Capital And Underwriting Results; Outlook Stable, Aug. 11, 2023
• Sustainability Insights: Why Climate Risks Are Changing So Few Corporate Ratings, April 12, 2023
• Bigger Flood And Fire Tests Lie Ahead For Australia, Jan. 17, 2023
• China Auto Manufacturer Zhejiang Geely Holding And Subsidiary Geely Auto Outlooks Revised to Negative On Margin Pressure, Nov. 21, 2022
• Bank Regulation And Disclosure To Foster Climate-Related Risk Analysis, Oct. 3, 2022
• American Family Mutual Rating Lowered To 'A-' From Underwriting And Investment Challenges; Outlook Negative, Aug. 25, 2022
• Royal Schiphol Ratings Lowered To 'A-/A-2' On Reduced Capacity Cap; Outlook Stable, July 21, 2022
• Chilean Power Co ILAP Downgraded To 'BB-' From 'BB' On Market Volatility, Depressed Conditions; On CreditWatch Negative, June 24, 2022
• Weather Warning: Assessing Countries’ Vulnerability To Economic Losses From Physical Climate Risks, April 27, 2022
• Through The ESG Lens 3.0: The Intersection Of ESG Credit Factors And U.S. Public Finance Credit Factors, March 2, 2022
• Enel Chile S.A. And Enel Generacion Chile Downgraded To 'BBB' From 'BBB+' On Expected Higher Leverage, Outlook Stable, Jan. 24, 2022
• Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021