“Uninsurable world” poses systemic risk
As the United States rolls back the climate risk mitigation measures of the previous administration, elsewhere the implications of rising temperatures are being keenly studied. This is particularly the case in the insurance industry which is effectively pronouncing more and more assets uninsurable with far-reaching consequences.
Disruption to the global labor market as a consequence of climate change is the focus for a recent report by the Centre for Economic Transition Expertise (CETEx) at the London School of Economics. It warns that climate-driven shocks would lower labor productivity, particularly in agriculture, construction and other sectors exposed to heat – even under an optimistic scenario where global warming is limited to 1.5–2 degrees.
With some 1.2 billion workers vulnerable to climate disruption, the report urges central banks to integrate environmental employment risks into their policies and operations, warning that labor market disruptions could “weaken the effectiveness of the transmission of monetary policy to the economy.”
But the CETEx report is just one of many expressing concern over mounting climate risk and its implications for the financial system.
Table of contents:
- Climate change directly affecting growth
- Climate risk models underestimating impact
- Uninsurable risks on the rise
- Systemic risk threat
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Climate change directly affecting growth
In early 2024, Reuters reported that the Bank of England was approached by a group of institutional investors intimating that UK banks might not be holding sufficient capital to cover climate risks and calling for more extensive climate risk disclosures by leading banks. The Bank of England did not comment on this. It publishes an annual climate-related financial disclosure that sets out its approach to managing the risks from climate change and reflects its “commitment to transparency, accountability and collaboration.”
In July this year, the European Central Bank (ECB) reported that extreme weather events have the potential to cause an almost 5% drop in euro area growth in the near term and it projects a 15% drop in global GDP under current policy settings.
This was based on a scenario designed by the Network for Greening the Financial System (NGFS), a group of central bankers and supervisors tasked with assessing the impact of climate risk on the financial sector and the economy. The NGFS has developed a set of tools to help banks and companies evaluate the impact of climate change on business. The US Federal Reserve withdrew from the NGFS at the beginning of the year, stating that the increased scope of the NGFS fell outside its mandate.
In early 2024, Reuters reported that the Bank of England was approached by a group of institutional investors intimating that UK banks might not be holding sufficient capital to cover climate risks and calling for more extensive climate risk disclosures by leading banks.
Climate risk models underestimating impact
Alarmingly, there is growing unease among central bank analysts that their models are more likely to underestimate risk as they fail to take into account the negative potential of climate tipping points.
A similar conclusion was reached by the Institute and Faculty of Actuaries (IFoA) earlier this year. This body believes that economic models vastly underestimate climate-driven risks and predicts a 50% loss to GDP in the event of temperatures rising 3 degrees between 2070 and 2090.
ESG is now business-critical. However, is internal fluency falling behind?
Alarmingly, there is growing unease among central bank analysts that their models are more likely to underestimate risk as they fail to take into account the negative potential of climate tipping points.
Uninsurable risks on the rise
Nowhere are the effects of climate change as keenly monitored as in the insurance industry, where distress calls around climate are becoming increasingly vocal.
One notable recent intervention came from a member of the Board of Management of insurance giant Allianz, who drew attention to the potential for systemic risk to the financial system arising from the increasing uninsurability of many risks. Allianz followed up with a white paper, “Climate change: Our responsibility to act” that developed on this theme. Climate change is transforming the risk landscape, the paper stated unequivocally.
Nowhere are the effects of climate change as keenly monitored as in the insurance industry, where distress calls around climate are becoming increasingly vocal.
Systemic risk threat
Since the early 2000s, about one-third of natural disaster losses have been insured. Although insurers expand their scope of coverage to take account of a wider range of risks, insurance is priced to reflect the particular risk. This sometimes means that premiums become unattractive or unaffordable for customers. Hence, although insurers are covering more risks in aggregate, uninsured risks may grow even faster.
The growing insurance gap, according to Allianz, “threatens the foundations of economic stability and thus societies. When insurance becomes inaccessible, credit slows, investment stalls and development is disrupted.”
This new scenario is not a one-off market adjustment but a systemic risk that threatens the very foundation of the finance sector. In the face of climate change, all kinds of risks are rapidly becoming uninsurable and other financial services become unavailable too. A bank cannot lend to any business or against any asset where risk cannot be insured. This applies not only to housing, but to infrastructure, transportation, agriculture, and industry in general. Allianz warns that “The economic value of entire regions – coastal, arid, wildfire-prone – will begin to vanish from financial ledgers. Markets will reprice, rapidly and brutally.”
Ultimately, the health of the planet is intricately linked to the stability of the financial system, and non-sustainable economies and societies are inherently risky.
Intuition Know-How, a premier digital learning solution for finance professionals, has several tutorials relevant to the content of this article:
- Climate Risk – An Introduction
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Climate Risk – Measurement
- Climate Risk – Management
- Climate Change – Physical Risks
- Climate Change – Transition Risks
- Sustainability & Sustainable Development
- Net Zero
- Decarbonization
- Business of Insurance
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