According to the National Oceanic and Atmospheric Administration (NOAA), as of September, 2023, this year’s climate disasters alone have cost more than $57.6 billion. The shocking amount of increasing losses, in combination with the exit of P&C insurers from certain high risk areas in the U.S. has generated much attention to the fiscal health of insurers and potential systemic risk. A study published in July of 2023 by the Federal Reserve Bank of New York, “Measuring the Climate Risk Exposure of Insurers,” introduced a groundbreaking new method for measuring the economic impact of Physical and Transition Risk due to climate change. Named “CRISK”, the method entailed the computation of insurers’ expected capital shortfall in a climate stress scenario. The study’s four authors include 2003 Nobel Prize-winning economist Robert Engle, the pioneer in time series analysis. Dr. Engle’s ARCH model and its generalizations have become indispensable tools not only for researchers, but also for analysts of financial markets, who use them in asset pricing and in evaluating portfolio risk.
The authors simulate losses due to climate change in the insurance industry, and make predictions about systemic risk. Two types of risk were analyzed: Physical Risk for P&C insurers, and Transition Risk for life insurers. While Physical Risk is associated with direct damage to properties due to climate change, Transition Risk is actually associated with the market; in the case of life insurers, these risks stem from corporate bond holdings, and losses that are predicted to occur due to the transition away from fossil fuels. Good news for the top ten P&C insurers – the paper concludes that in terms of Physical Risk, current risk levels are acceptable. They found “no sign of potential systemic undercapitalization under physical climate stress. As of the end of 2020, their aggregate marginal CRISK stood at $ 15 billion, equivalent to approximately 7% of their market cap.” The report highlights potential problems with Transition Risk for life insurers, caused by investment in industries exposed to Transition Risk. The authors observed “a notable increase in their transition climate beta during the 2019-2020 fossil fuel price collapse.”
Beyond the paper’s immediate conclusions, it highlights the rapid evolution of tools and methodologies designed to address the most critical need in finance today: predicting the effects of climate change and quantifying the associated economic risks. We’ll be discussing the latest tools and methodologies to predict, measure and quantify climate risk in the U.S. real estate, housing and housing finance ecosphere at AmeriCatalyst’s “GOING TO EXTREMES” Climate, Housing and Finance Leadership Summit at the Gaylord National Harbor (Washington DC) on April 18 and 19, 2024.
Sources:
“MEASURING CLIMATE RISK EXPOSURE OF INSURERS”, FRBNY Report
Authors: Hyeyoon Jung, Robert Engle, Shan Ge, and Xuran Zeng | July 2023