Physical Climate Risks - Fostering a mutually beneficial dialogue between investors and insurers

For investors in real assets, physical climate risks can impact asset value through a combination of changes in revenue, higher operational costs and – potentially – difficulty securing insurance. 

There is a clear link between reducing the vulnerability of real assets through investment in resilience, improved insurability and value creation. The issue is to develop the tools and metrics that will allow investors to navigate through this. 

Working alongside the Institutional Investors Group on Climate Change (IIGCC) as part of their prestigious Adaptation and Resilience working group, Howden's climate risk and resilience team have been able to gain a number of high-level insights on the challenges billion-dollar institutional investors face integrating Physical Climate Risks (PCRs) into their decision making.

We've also been included in the development of the Physical Climate Risk Methodology (PCRAM) work IIGCC has taken on as part of the Coalition for Climate Resilient Investment legacy programme. (You can find out more about PCRAM here.)

IIGCC will be sharing some of their insights in a future discussion paper on understanding physical climate risks in real assets, which will address using PCRAM for both risk management and value creation, but they've generously allowed us to get ahead of the game, and share some of them here.

Here, we present some of the most intriguing insights from the report. 

The increasing role of PCR assessment as part of due diligence
 

It’s clear that assessing PCRs is becoming more common in institutional firms within their investment decision making and asset evaluation process:

     “We consider PCR at least annually, if not more often.”
     “During due diligence we do PCR screening and [identify] where we think PCR could be material to the underlying asset.”

In other cases, institutions are already keeping PCRs in mind, even if their own assets under management are still being developed and PCR isn’t yet relevant in a practical sense.     

Interestingly, it’s clear that while many firms are taking physical climate risk into account as part of their due diligence, their frameworks and methods can vary. IIGCC’s upcoming report will explore this in more depth.  

The approaches to quantifying the impacts of PCRs to investments are always evolving, so it’s no surprise that respondents were facing some difficulties in making use of the available data.   

In fact, two key challenges have emerged...

Challenges with data and modelling
 

"Biggest challenge for us is the lack of data harmonisation; there is limited transparency in the model methodology, so different models produce different insights.”

These investors are all members of IIGCC, so we can assume that in terms of climate integration, they’re much higher on the awareness scale than your average investment firm. But even taking this into account, it's obvious that access to high-quality data and a lack of trust in the data that is available are both serious concerns. 

Another key sticking point is the lack of consistency across the available data models:

     “Reviewed 29 data products and found various modelling inconsistency (underlying metrics, sensitivity and granularity were different).”
     “Knowledge gap and a lack of standard procedures around understanding PCR assessment[s] makes it hard for us to evaluate risks.”

Understandably, there is a sense of frustration here that's worth paying attention to.

In the end, until available data makes it easier to accurately assess the insurability of assets and the potential benefits of resilience measures, it's likely investment firms will continue to see data more as a tool to ensure regulatory compliance than as a valuable part of their risk management and investment strategies.

Which is why resilience and insurability is so vital. 

The fight to maintain insurability
 

It’s no secret that at Howden, we believe the insurance market will play  a vital role in helping businesses build their resilience against the increasing volatility and uncertainty of climate change. 

This means that ensuring both long-term insurability and asset value protection will be crucial. IIGCC members highlighted to major areas of concern in terms of using insurance as part of improving resilience in PCR-exposed assets. 

First, the cost of insurance premiums. Secondly (as detailed by a number of members) was simply the availability of coverage for assets exposed to PCRs: 

     “Reduction in the level of cover.”
     “Exclusions of particular material risks.”  

Importantly, though, that didn’t stop the investors from clearly demonstrating that despite the challenges, they are aware of the potential  of insurance to solve those challenges:

     “We see value in insurance, but there is still a lot of information around adaptation risk…”
     “We see the benefits of insurance, and data and analytic tools.”
     “We see value in insurance while making new investments.”

The desire for effective insurance solutions was also demonstrated by the fact that while none of the investors we talked to had currently identified the optimum resilient investment point for their assets (the point beyond which tail risks would be transferred to insurance), every respondent declared their interest in gaining new insight in this area.

Unlocking significant investments in resilience
 

Collectively, the investors in the Adaptation and Resilience working group manage more than $8tn in assets (of which a significant portion is invested in real assets). And it’s plain that PCRs are something they take very seriously.

In a sense, that makes the effective use of insurance in helping them  mitigate that risk a trillion-dollar opportunity. We believe adopting resilience measures can help reduce the impact of such risks and create a virtuous circle where investment in resilience can increase asset values and improve insurability.

Investors can enhance an asset’s ability to withstand and recover from disruptions, and secure more predictable cash flows. This can reduce the likelihood (and severity) of any losses should be reduced, which can help insurers price PCRs in a way which incentivises further investment and  mobilises finance to de-risk the transition. 

In turn, this reduced risk profile will make it easier for insurers to assess and underwrite tail risks, which can then increase insurability for assets moving forward. 

Howden is committed to making this happen.

Our goal is to provide both capital and risk management governance, and to drive collaborative efforts among insurers and investors to help manage climate risks in future.

By fostering a dialogue between insurers and investors, we can all work together to develop a mutual understanding of the risks faced, and increase resilience within the industry as a whole. 

In fact, we're already working alongside IIGCC in developing PCRAM, designed to help bridge the gap between the infrastructure and financial sectors by providing a consistent approach for evaluating climate risks across both public and private finance.

If you're an investor, and you'd like to know more about how we can help businesses like yours integrate the impacts of PCRs into your investment decisions, and enhance the resilience of those investments, our specialist Climate Risk and Resilience team would love to hear from you.

You can find out more about Howden's work here.

Or, if you'd like to get in touch directly, please fill in our secure online contact form here.