Climate impacts: Field of action finance and insurance sector

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Climate change affects the business risks of insurers and credit institutions.
Source: checka/

Financial and insurance service providers are confronted in various ways with the risks and consequences of climate change. The increase in climate-related damage cases is increasing the demands on risk analysis and risk management. The danger of "stranded assets" is also increasing, i.e. a loss of value of investments due to climate risks.

Insurance industry

The increase in extreme weather events is particularly relevant for insurance companies. According to the reinsurer Munich Re, weather-related natural catastrophes have caused losses of around USD 4.2 trillion worldwide since 1980. Indirect losses such as the interruption of supply chains, credit defaults at banks or the curtailment of power plant production during heat waves are not included in this figure.

The amount of damage caused by extreme weather events fluctuates from year to year. The insurance industry's Natural Hazards Report 2020 puts the property damage caused by storms, hail, floods and heavy rain in Germany in 2019 at three billion euros. The long-term average is 3.7 billion euros.

Climate change is not the sole cause of the increase in financial losses due to extreme natural events. The general increase in insured values also plays an important role. Accordingly, insurance payments will probably not only be higher, but also claimed more frequently.

However, there are also gaps in insurance coverage in Germany. The insurance density for storm and hail insurance is 94 percent. For natural hazards such as flooding or heavy rain, however, it is only 43 percent for building insurance and only 24 percent for household insurance. Yet the demand for natural hazard insurance has risen significantly in recent years. In 2002, the share of residential buildings with such policies was only 19 percent.

Surveys show, however, that risk awareness among the German population is not yet sufficiently pronounced. This can become a problem for the insurance industry. Only if awareness of climate risks is broadly anchored and, as a result, many people take out insurance can sufficiently large risk communities be formed for insurance to ensure that insurance premiums are affordable.

For insurance companies, the increase in losses from natural hazards is a major challenge, especially due to the uncertainties associated with climate change regarding the occurrence of extreme weather events. A linear projection of extreme weather trends does not provide sufficiently reliable estimates for the future. This makes it difficult to calculate insurance premiums. Advances and innovations in data availability, modelling and risk assessment are therefore of central importance for the insurance industry.

Due to the additional climate risks, this may lead to an increase in insurance premiums under certain circumstances. Insurers and policyholders should be able to counteract this by taking timely adaptation measures. Nevertheless, the general insurability in particularly exposed locations may increasingly be called into question due to excessively high loss potentials. This in turn has implications for the public sector as the "insurer of last resort", which would have to step in - in addition to damage to public infrastructure, the costs of disaster management and, for example, the reconstruction of flood protection.

So far, the extent of climate impacts in Germany is considered to be largely manageable for insurance companies. Thanks to a well-functioning reinsurance market, the insurance industry can cope well with the impacts of extreme climatic events. If insurance companies increasingly operate on global markets, there is a higher risk that they could also be affected by the impacts of global climate change.

Indicators from the monitoring on the DAS: Claims ratio, combined ratio in homeowners’ comprehensive insurance, Incidence of storms and floods

Banking industry

Climate-related risks have become increasingly important for the banking industry as a lender, investor and advisor to investors in recent years. These risks manifest themselves in different ways. For example, extreme weather events can cause damage and longer-term production losses in companies to which banks have lent or in which they hold shares. This can lead to loan defaults and higher refinancing costs. Investors will also experience yield losses due to declining corporate profits and the reduced overall value of the company.

For internationally active companies, there is also an increased risk of disruptions in the supply chain due to climatic events in other regions of the world. This can also lead to production delays or failures with a corresponding loss of return.

Lenders can protect themselves against possible climate risks by taking out appropriate insurance. The review of relevant insurance policies is thus gaining in importance.

The so-called transition risks are becoming increasingly relevant. Regulatory interventions in the course of ambitious climate protection efforts as well as changes in the economic structure, such as a switch to renewable energies and more sustainability, increase the danger of "stranded assets", i.e. the loss of value of assets on the balance sheets of the banking industry. This increases the requirements for the valuation of investments, especially for long-term investments, for example infrastructure projects, as climate risks will have to be taken into account to a greater extent in the future. Investments in projects or companies severely affected by climate change could therefore decrease in the future.

Reputational risks associated with investments in climate-damaging projects also play an increasing role for the financial sector.