Cluster Financial services industry

Banks, savings banks and insurance companies are important players in the transformation process towards a CO₂-neutral and climate-resilient economy. These organisations play a key role in the implementation of the European ‘Green Deal’ which is striving to achieve the transition to a climate-neutral, resource-efficient and competitive economy by 2050. It is beholden to credit institutions to provide sufficient liquidity for essential investments – for both climate protection and for climate-related damage. Underwriters have an important part to play in terms of the collective assumption and sharing of risks. The implementation of the Green Deal requires an absolutely fundamental transformation process which can succeed only provided it is based on a stable financial system. This must be based on well-functioning risk management which is resilient in both commercial and climatic terms.

Apart from being important players in respect of climate protection and climate adaptation, financial services providers are equally vulnerable to the impacts of climate change in respect of their own operations. In terms of risks, insurance companies and credit institutions are closely linked to their clientele; this is to say – both private individuals and companies. In other words, physical climate risks – the impacts of extreme weather events and weather patterns as well as the creeping progress of climatic changes facing their clientele – can easily turn into commercial risks confronting financial institutions. For quite some time, the insurance companies have been scrutinising the potential impacts of climate change. By contrast, negative impacts of climate change on the credit history and liquidity of borrowers or any potential losses in the value of assets, have so far been considered less of a risk by credit institutions. This is true, in particular, for regional credit institutions which are active almost exclusively within Germany. The general commercial risks encountered by insurance companies are quite specific in line with the different insurance products concerned, and the risks involved affect the profitability of insurance products. For example, liability insurance or household insurance products are typically more profitable whereas homeowners’ comprehensive insurance regularly incurs underwriting losses. The profitability is calculated on the basis of the combined ratio. If this ratio amounts to more than 100 %, the insurance company incurs a loss regarding the relevant policy transaction. Over the past 20 years, extreme weather events have repeatedly entailed underwriting losses in respect of homeowners’ combined insurance (cf. Indicator FiW-I-1). In terms of insured damage, 2021 has been the most costly year so far – to the tune of 11 billion Euros – as a result of the flood disaster with focus Ahrtal.

The financial services industry in general is covered as a cross-sectional action field in the 2021 Climate Impact and Risk Analysis (KWRA) This is why climate impacts have not been described, and no climate impact assessments were carried out either. In the DAS action fields a special focus has been placed on the insurance sector and the banking sector owing to their relevance to increasing the adaptation capacity.

Contrary to the indicator set for the DAS ‘Financial services industry’ action field contained in the previous 2019 DAS Monitoring Report, the current issue has been amended to include an additional Response Indicator (FiW-R-2). Nevertheless, it has not been possible so far to include any quantitative indicators, especially with regard to those themes which play an important role in the banking sector: There are no representative data available to describe either the extent to which banking businesses are affected by climate change impacts or the relevant risk management by banks: Germany’s banks have only just begun to address the subject of climate change in a systematic manner. However, regulators and politicians with relevant remits have been scrutinising the climate-related impacts on the industry ever more closely.

At the European level, the current issue was amended substantially by including a revised version of ‘Corporate Sustainability Reporting Directive – CSRD’ published in 2022 and the European taxonomy regulation which came into force in 2020, thus distinctly amending the non-financial reporting system. As a result, the resilience to climate change and the objective of climate protection have become a distinct focus of corporate reporting. Furthermore, there are regulations imminent on the part of the European Banking Authority (EBA) and Germany’s Federal Financial Supervisory Authority (BaFin) which will oblige the system- relevant banks to submit a differentiated declaration of the amounts of credit exposed to physical climate risks. The data contained in such reports will provide greater transparency in future. Given the fact that – at least some of – the data will be in the public domain, this opens up new possibilities for illustrating, by means of DAS Monitoring Indicators, how climate risks are addressed in the financial services industry. Against this background, the indicator on the awareness of physical climate risks among financial services providers (FiW-R-2) published for the first time ever in the 2023 Monitoring Report, is to be understood as a proxy indicator. This proxy indicator is based on a small dataset – covering a few financial services providers who voluntarily submit reports within the framework of the CDP – and is primarily intended to embed the important issues of climate change management in the core principles of financial services management in respect of DAS Monitoring.

The amendments mentioned which were added to the European and German reporting obligations, apply not just to the banking sector but also to insurance companies. In the insurance sector too, there are still some deficits remaining with regard to the systematic assessment of climate risks as well as risk management. Given that climate risks have, in part, a very direct effect on the profitability of certain insurance products, insurance companies are in general more proactive in addressing climate change impacts facing the insurance market. Since 2012, the GDV has been publishing their annual natural hazard report as a damage ‘chronicle’ of German insurers. Reinsurers too, such as the Munich Re, have for some time had their eye on the impacts of climate change. On the basis of GDV data, it is possible to generate indicators on insurance products already established in the market – such as the extended insurance for buildings against natural hazards (eEV) which has been available since the 1990s; that is to say, indicators on damage data (cf. Indicators BAU-I-5 and FiW-I-1). As far as insurance products are concerned which are not yet firmly established in the market and which have as yet low insurance density, such damage data are not yet sufficiently representative.

Apart from the eEV mentioned above, work is ongoing regarding further insurance products intended to provide insurance for climate risks in the future, especially in the field of agriculture. Although the GDV supports the discussion on the development of climate risk insurance and is in the process of enhancing product design, the association does not have an overview of the question as to whether and how its member organisations will ultimately implement those developments in the form of marketable products. Owing to keen competition prevailing in the insurance market, the member organisations are being very discrete about publishing their individual strategies and product developments. It is therefore not possible to illustrate the market development in terms of indicators.

Insurance companies, credit institutions and other players in the finance sector face various challenges in connection with climate change. The credit institutions have to ensure when checking for credit eligibility that climate protection and adaptation are taken into account and that after granting credit there is adequate liquidity available to provide claims settlement after cases of climate-related damage and for any reconstruction work required. Underwriters have an important part to play in terms of the collective assumption and sharing of risks.

It is evident from scientific analyses that banks are still addressing the issues of risk management and climate change adaptation inadequately and in a manner that is not sufficiently systematic (cf. Indicator FiW-R-2). Transitory risks still dominate the foreground of their awareness. These are regulatory risks due to more stringent climate protection requirements imposed on the clientele, as well as reputational risks which can be linked to banks’ investments in climate-damaging projects. In general a greater damage potential is attributed to such risks than to physical climate-related risks. Especially in the case of internationally active banks which also do business in highly vulnerable countries (cf. Indicator IG-R-2), this ‘blind spot’ involves a substantial risk potential. However, physical risks are also directly or indirectly relevant to regionally active banks.

The developments intended to improve transparency in the risk management practised by financial services providers (CSRD, as well as transparency of taxonomy regulation and new regulations introduced by EPA and BaFin) will in future contribute to a more intensive analysis of physical risks and – as expected – to the implementation of risk-mitigating measures. On one hand, higher transparency is important in examining whether the efficacy and stability of banks will prove resilient in crisis situations. On the other hand, transparency helps potential investors to take informed decisions. At the same time, the generally increasing awareness of climate protection and sustainability has resulted in a growing demand for sustainable capital investments.

With its products, the insurance sector basically makes an important contribution to the transfer of social risks. Climate risk policies are regarded as core strategic tools for adaptation to climate change. For example, the Sendai Framework for Disaster Risk Reduction 2015–2030 is being used to highlight the importance of insurance policies in reducing disaster risks and increasing the resilience of populations and institutions in the face of disasters. Likewise, in the 2021 EU Adaptation Strategy, closing the gap in insurance protection from climate risks is regarded as an important step towards achieving a climate-resilient EU. Currently, on average of roughly just 35 % of climate-related commercial losses are currently covered by insurance Europe-wide, while in some parts of Europe as little as 5 % or less are covered²¹¹.

There are two essential prerequisites to be met in order to achieve a more extensive insurance cover: on one hand, the availability of attractive insurance policy offers, and on the other, the population’s willingness to take up the offer of insurance products. The further development of appropriate insurance instruments is being pursued worldwide. By now, the eEV is well established in Germany; however, the insurance density is still rather patchy (cf. Indicator BAU-R-4). As far as agriculture and forestry are concerned, there is still a lack of suitable offers in respect of climate risk insurance products. The existing offers are not much in demand owing to high costs and lack of financial support from the state. In general terms, the finance industry has great potential to expedite the innovations necessary to adapt their insurance products to market requirements. In addition, such endeavours might be supported by accompanying scientific studies²¹².

Given the still insufficient risk awareness among the population (cf. Indicator FiW-R-1), there seems to be a need for more strongly and more intensively bundled information on climate risks. In order to raise public awareness of the risks of damage to buildings and to increase the willingness to take up insurance, several Länder carried out campaigns to draw attention to damage from natural hazards in recent years. In fact, the success of these campaigns was limited – a case of more or less preaching to the converted, in other words the response came mostly from people who were already sensitised to the issues.

Likewise, tools such as the ‘Hochwasser-Pass’ (flood passport) developed for the purpose of raising awareness, were not followed up in terms of interested parties taking effective action. By using the internet-based information tool ‘Naturgefahren-Check’ (natural hazards check) offered by the GDV, individuals who rent or own a house, as well as companies, can obtain information enlightening them to what extent their building is exposed to natural hazards and what adaptation measures might be implemented. However, this offer too, is expected to appeal just to members of the public who are interested anyway. With the aim to reach a wider public by using a more strongly bundled information offer, the DWD announced in 2022 that it planned to develop – in cooperation with LAWA and the Federal Office of Civil Protection and Disaster Assistance (BBK) – a natural hazards portal which can be used in future to obtain information (in digital form) on any concrete hazards prevailing at a specific location, as a basis for taking preventative steps.

Risk transfer via customised insurance solutions is not always sufficient, as insurance policies should at best be just a part of comprehensive risk management. In the optimum case, risk transfer is accompanied by strategies for operational risk mitigation. That is why many underwriters now conduct their own individual consultations, for example with regard to flood-adapted building methods; and they make the conclusion of insurance policies partly conditional on adaptation standards in order to mitigate risks thus also keeping insurance premiums as low as possible. In general terms, however, a distinctly more intensive form of cooperation between insurance companies, the public purse, consumer protection associations and the insured is called for. Discussions are taking place, for example, regarding a deeper embedding of adaptation commitments in legal and planning principles and in respect of regulations which are apt to direct, for instance, the development of housing estates towards areas that are less subject to climate risks (cf. Indicator RO-R-6). Other approaches might include adapting the insurance tax in such a way that insurance premiums become affordable, or by establishing state-guaranteed minimum insurance protection by creating a state-administered pool. In cases where damage arises, financial support might then be provided from this pool without burdening the tax payer or communalising the payment of damages. In this context, close cooperation with banks is equally important. For example the granting of mortgage loans might be made conditional on evidence of a natural hazard insurance policy; alternatively, such evidence might provide eligibility for an interest rebate on the loan.

^{211 - Europäische Kommission 2021: Ein klimaresilientes Europa aufbauen - die neue EU-Strategie für die Anpassung an den Klimawandel. COM(2021) 82 final, Brüssel. https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=COM:2021:82:FIN.}

^{212 - Sönke K., Sandholz S., Bulut S.S., Mirwald M., Kohler D. 2022: Klimarisikoversicherung – Potenziale als strategisches Instrument zur Klimaanpassung in Deutschland. Climate Change 13/2022, Dessau.Roßlau, 122 S. https://www.umweltbundesamt.de/publikationen/klimarisikoversicherung.}