As the effects of climate change intensify, extreme weather events are becoming increasingly frequent and severe. The US experienced 25 extreme weather events in 2023, each causing losses of over USD 1 billion, with a total cost of USD 73.8 billion.
These climate events have a huge potential impact on financial institutions. In 2021, large-scale floods affected the European countries of Austria, Germany, Belgium, the Netherlands and Luxembourg, causing USD 43 billion worth of damage in addition to a tragic loss of life. According to Berenberg analysts, individual insurance companies faced total claims estimates of up to approximately USD 300 million. Berenberg estimated that reinsurance losses ranged between USD 2 billion and USD 3 billion.
For other financial services firms outside of the insurance sector, property accepted as loan security might face climate-related risks as well. Longer-term local climate change risks might still devalue property that hasn’t suffered damage. These risks might include threats posed by sea level rises, wildfires, heat waves, flooding or other natural disasters.
Some firms might choose not to invest in certain landscapes where the physical risks are considerably too high. As a result, their market would shrink.
Across the financial sector, there are transition risks to consider as we move to a low-carbon economy. Many financial services firms will have to re-evaluate a significant portfolio of investments across the stock market. Financial markets might reprice shares in some carbon-intensive sectors by favoring renewable energy over fossil fuels. There might be reputational damage associated with investing in companies that are seemingly causing global warming with excessive greenhouse gas or carbon emissions, rather than mitigating it. Supply chain or other business interruptions due to extreme weather might also hit balance sheets in listed companies. As a result, pension funds and other stock market investments might suffer adverse effects.
Developing a risk management strategy for insurance and other financial services
In recent years, financial services firms have realized that they need a decision-making strategy that accounts for the implications of climate change. Methodologies used in the past might not be enough to account for new weather patterns and extreme weather events.
Firms can also reduce their investment risk by using weather and climate data to make investment decisions. When firms are trading energy, for example, they can forecast renewable electricity generation based on predicted solar and wind patterns. Companies can follow this three-step process to address the implications of climate change in their business:
1. Get tools to accurately assess potential climate impacts
The IBM® Environmental Intelligence Suite models 40 years of historical weather patterns. It enables forecasting on these time scales:
- Immediate weather scale, looking two weeks ahead
- Sub-seasonal scale, forecasting one year ahead
- Climate scale, modeling up to the year 2100
Using a graphical user interface (GUI), financial services firms can view properties in the context of the climate risks in their specific location. This GUI enables a more complete risk assessment when considering an insurance or mortgage application. Financial services firms can use the tool for “what if?” analysis to better understand the likelihood of various climate scenarios and help to draw up mitigation plans to counter extreme weather risks.
2. Create an operational strategy to use weather data
A new or expanded team might have to fully take advantage of weather data throughout the business. Firms might need to overhaul their risk assessment and portfolio management practices to include climate risk and opportunity. Companies can use weather data to help write damage assessment reports, guide risk assessors on location and identify insurance claims fraud. Investment decision-makers also need weather and climate data so they can use it for better-informed trading in sectors such as energy, agriculture and food.
3. Engage customers with new offers
There are new opportunities to attract and retain customers by sharing climate intelligence. Insurance companies can, for instance, alert their customers to threats that their properties face so they can protect them. To defend against wildfires, property owners could clear furniture and vegetation around the property that might spread flames to the building. In areas vulnerable to flooding, they could add flood defenses and protections. In this way, financial services firms can reduce their financial risk while also increasing customer satisfaction.
Financial services businesses can also create new products by using weather and climate data. For example, if an extreme weather event happens, parametric insurance offers an agreed fixed payment. Customers can get paid faster because there’s no need to assess damage.
To respond to climate disruptions and manage the increased risk resulting from extreme weather events, financial services firms need accurate weather insights. The delivery of these insights should enable firms to understand the climate risk associated with countries or properties that they are interested in.
Not only does weather data help reduce the extent of losses, but it also creates new opportunities. Renewable energy forecasting can inform energy trading and insurance companies can help homeowners understand both the threats their properties face and how to counter them. By cutting the cost of extreme weather events and seizing new business opportunities, financial services firms can turn weather data into a powerful competitive advantage.
Learn more about the IBM Environmental Intelligence Suite
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