Adaptation: Field of action finance and insurance sector

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

Climate change increases the business risk of banks and insurance companies. However, with the help of an active management, climate-related risks can be met to a great extent and new business opportunities can be exploited. In addition, the financial and insurance industry can create incentives for adaptation measures through product design and investment decisions.

Insurance industry

An active management of the increasing climate-related uncertainty factors initially requires a valid database. On this basis, future risks and possible damages can be assessed and appropriate premiums can be determined. Risk analysis should take advantage of innovative procedures such as scenario techniques because a simple extrapolation of the statistics of past events cannot adequately display climate change and its consequences.

The German Insurance Association (GDV) has developed a geographic information system for floods, high water and backwater (ZÜRS) to calculate the insurance premiums for building insurances against natural hazards such as floods, hail or storm. Through the use of such information systems, the region-specific data availability can be increased significantly and the assessment of local risks is improved.

In addition, incentives for risk reduction can counteract the increasing damage incidents. For that purpose, it is first important to raise awareness of the changed risk situation amongst the population through information and education campaigns and targeted advice provided to policy owners. Geographic information systems can be used for this purpose, too, as the example ZÜRS public shows.

In addition to information campaigns, flexible premiums such as premium discounts for technical preventive measures against floods in vulnerable areas can motivate policy owners to adopt adaptation measures. Also a mandatory natural hazard insurance – possibly with a graded deductible – is recommended, as these could motivate property owners to implement damage prevention measures. In case of particularly high risk potentials, deductibles, fixed maximum amounts or limitations of the insurance coverage could provide additional incentives to reduce individual risks.

To secure the solvency of insurance companies in case of increasing damage incidents, an increase in equity could become necessary, too. The development of new financial products with which climate risks of policy owners such as companies or municipalities are scattered on the capital market constitutes another possibility for the insurance industry. Examples include weather derivatives or catastrophe bonds.

Insurance protection opens up further market opportunities for products or technologies that become increasingly important in the wake of climate change, for example wind turbines.

Furthermore, insurance companies can increase their adaptability through cooperation with other actors. Thus, insurers, reinsurers, environmental organisations and scientists have established the Munich Climate Insurance Initiative (MCII) to develop strategies to deal with the risks of climate change.

Banking industry

Investors should work to ensure that climate risks become an integral part of investment decisions. Potential investment objects should be subject to systematic climate risk assessments. Therefore, a reliable and comparable information base is necessary for the assessment of such risks.

In this context, it is worth mentioning the Carbon Disclosure Project (CDP) that combines approximately 300 institutional investors, including large German financial service providers. Apart from information on company-specific greenhouse gas emissions, it also provides information on how to deal with the physical risks of climate change. However, also beyond this project investors can assess whether the company in question performs effective adaptation measures to climate change before deciding to invest in companies.

Especially when it comes to companies that are influenced by their investors due to their bonds and investments it is possible to demand a risk-conscious corporate policy. In case of non-adapted companies, investors can thus demand higher risk premiums.

Climate change also provides banks with new business sectors. Examples are climate-friendly financial services and investments in innovative climate technologies.

If you are interested in obtaining information about concrete impacts of climate change in the field of action finance and insurance sector, please click here.