Don’t Shy Away from Extreme Weather, Act on It

The extreme weather events of 2021 have taken many of us by surprise. Snow and ice in Texas, an extreme heatwave in Vancouver and Portland, devastating floods in Germany, Belgium, Turkey and China – just a few of the weather events that have caught citizens and governments unprepared. Some natural disasters are once in a lifetime happenings, but as the planet warms up scientists predict that these will happen more often than we think.

The increasing intensity and frequency of extreme weather events combined with population growth and urbanization has financial and social consequences. According to the insurer Aon, about 3000 people died because of natural disasters in 2021. Global insurers have picked up the tab of US$40 billion for the first half of 2021. Natural disasters are likely to be more costly for insurance companies in richer countries where businesses and citizens tend to be better insured. In the Financial Times, reinsurance group Swiss Re predicted that for 2021 ‘the stage is set for what could be record losses’.

With increasing urbanization, cities have become epicenters of economic activity. More than half of the world’s population now live in urban areas. In these highly dense cities, the amount of people and their assets endangered by extreme weather events is large and growing. As the climate continues to change and extreme weather patterns become an increasingly material issue, coupled with the changing patterns of urbanization, forecasting is extremely relevant in the now as well as into the future.

Some financial institutions (insurers, asset managers, and pension funds), companies, and countries are already evaluating their current risk models and adapting them to the new trends that are emerging, forecasted by scientists and actuaries. In the coming years, all companies and governments will have to do the same. As climate change is already happening and the world is – according to the latest IPCC-report – still on its business-as-usual track, financial institutions have to be prepared to adapt to the scenario of the Failed Transition Pathway¹ that estimates a global temperature rise of 4°C in 2050.

Even if at the next UN Climate Conference in Glasgow, the COP26, governments and industry agree to step up climate change efforts to reach net-zero emissions by 2050, we still have to prepare for even more disruptions, such as floods and heatwaves, than we have experienced in the last 10 years. The World Meteorological Organization states on its website that 2011-2020 was the warmest decade on record, in a persistent long-term climate change trend and that 2016, 2019, and 2020 were the hottest years on record. Some changes, such as the melting of the Arctic sea ice and the sea level rise are already ‘irreversible’ according to the latest climate report by the IPCC.

Assess, act, and be resilient

For investors who are still working out what to do with climate risk and how to decide where to start changing their portfolio, the observation of economics professor and Nobel Laureate Robert Engle that ‘the physical risks of climate change may precede the transition risks that would arise from government intervention’ can be helpful. Engle won the Nobel Prize in 2003 for his work on volatility and says that if we look at climate risk as a risk management problem: ‘uncertainty doesn’t mean do nothing. It means having a plan that’s appropriate for how you see the risks.’ It is all about decision making in the absence of full information.

For us at Ortec Finance, the starting point is to assess which regions are most at risk of natural disasters and extreme weather events. Hazard information is fundamental for calculating risks of events before they occur and subsequently for documenting loss and damage. Being aware of where trouble lies ahead is already the first step. For example, it is important to know that the manufacture of microprocessors is concentrated in Asia and mostly in zones with severe weather exposure. According to a report from McKinsey published in August 2020, the probability of a hurricane of sufficient intensity to disrupt semiconductor supply chains may grow two to four times by 2040. In short, financial managers must assess where the most material risks in their portfolios lie.

Adapting to the fast changing physical and financial climate is challenging. How to find the best scientific information and what is the best way to address the uncertainty can feel like an insurmountable challenge. Fund managers, from insurance, pensions, and bond markets need to be able to understand and spread their risk. Local factors, such as grid resilience, labor, and governance remain important as well. The climate factor has become at least as important, which means that accessible, timely knowhow is key to designing climate-resilient investment plans. Ortec Finance’s Climate PREDICT solution is here to help you navigate these uncharted waters, fast.

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^{1 Ortec Finance and its partner Cambridge Econometrics work with two climate change scenarios. The second one is the Paris Transition Pathway, orderly fashion, which estimates the global temperature will rise with 1.5°C, as is agreed in the Paris Climate Agreement of 2015.}

 

Learn more about our Climate Scenario Analysis Solution - ClimateMAPS