Physical climate risk
Risk of financial losses resulting from the physical effects of climate change, whether acute events (catastrophes) or chronic trends (sea-level rise, droughts).
The Task Force on Climate-related Financial Disclosures (TCFD) published its recommendations in June 2017. They separate two risks. Physical climate risk covers the financial losses and exposures caused by the physical manifestations of climate change. Transition risk arises from the policies and technologies deployed to address it. The TCFD splits the first into two components, and its reporting standard names both. Acute risks are extreme events of growing frequency and intensity: tropical cyclones, floods, heatwaves, wildfires, droughts. Chronic risks are long-term trends such as sea-level rise, permafrost thaw, changing precipitation patterns or ocean acidification. An insurer meets physical risk twice. On the liability side, it shows in the loss experience of property, liability, agricultural and catastrophe reinsurance policies. On the asset side, it erodes the value of investments: a building in a flood zone or a loan portfolio exposed to rising seas loses value. EIOPA has built climate stress-test scenarios into its prudential supervision of European insurers. The actuarial difficulty is non-stationarity. Historical data no longer represent a climate future whose parameters keep moving, and the pricing actuary has to shift to forward-looking approaches based on IPCC scenarios.
A property insurer has 40% of its residential portfolio in coastal areas likely to be flooded by 2050 under IPCC RCP 4.5 scenarios. In its climate ORSA requested by the ACPR, it models the impact on its solvency ratio and concludes it must increase premiums by 15% in those zones or gradually reduce its exposure, or its SCR ratio will fall below 120% by 2035.
Physical climate risk, physical risk climate
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