Why modelling physical climate change risk is a business necessity

Find out how physical climate change risk modelling can provide businesses with actionable intelligence to enhance climate resilience.

When it comes to effective risk management and fulfilling climate reporting obligations, physical climate change risk modelling is an essential part of the process.

Driven largely by rising global temperatures, extreme weather events such as typhoons, floods, and heatwaves are becoming more frequent, with climate-related disasters worldwide increasing 83% in the past 20 years.¹ Severe extreme weather events, such as floods, storms, and wildfires, have caused a magnitude of losses unheard of prior to 2011 — with insured losses of US$5 billion or higher in four of the last five years.²

Further challenging businesses’ ability to recover from impact of these climate hazards is the inadequate level of insurance coverage in Asia, where 90% of losses are uninsured.³

With the sustainability of businesses on the line, accurately diagnosing and pricing physical climate change risks can help organisations answer many of the questions on how to mitigate and transfer the risk optimally. Physical climate change risk modelling can achieve this by providing an understanding of potential losses for an asset or portfolio of assets across a variety of peril scenarios and timeframes (i.e. both near-term and long-term).

What is physical climate change risk modelling?

Physical climate change risk modelling uses a combination of historical event data and downscaled global climate projections to identify the impact of different perils, from catastrophic threats like flooding and typhoons to more chronic stresses like droughts on a business’s assets and operations.

The results should provide businesses with a highly-detailed, asset-level view on damages and business interruption implications for specific perils, as well as an organisational-level perspective on key risks.

Common mistakes when modelling physical climate change risk

Not all physical climate change risk models and approaches are the same. To obtain actionable intelligence, businesses need to ensure their chosen process is robust and backed by reliable scientific and engineering data appropriate for the geography of interest. When starting the process, businesses might overlook the following considerations:

Not selecting the right and most critical perils to model.
Not modelling the appropriate climate scenarios and time horizons.
Not knowing the right vendors and how many to go with.
Model is not up-to-date or use inaccurate geolocation data.
Model cannot be interrogated, customised or challenged fully to ensure its accuracy and integrity for business use.
Vendor is unable to supply the relevant outputs to actively support your business in meeting regulatory requests.

How to overcome the challenges of physical climate change risk modelling

Choosing the right risk advisor is vital. Look for an expert that can work with leading catastrophe and climate change risk model providers to create an up-to-date, model-agnostic, and fully-owned approach to climate risk, and ensure accurate and relevant outcome data from physical climate change risk modelling. This seven-step framework can help businesses extract meaningful value from the outcome data:

Figure 1 - Seven-step framework

Through this framework that can be tailored to your portfolio, businesses can achieve the following outcomes:

Identify and understand the different physical climate change risk exposures found in existing sites and assets (or potential new locations to expand operations).
Design and implement resilience and risk reduction options.
Justify resiliency decisions to investors and stakeholders.
Prevent underinsurance and optimise coverage for changing risks.

From the modelling process, businesses should also be able to obtain actionable insights that enable them to effectively refine and enhance their extreme weather risk management approach. For a financial institution, this could mean translating physical loss projections into credit risk implications. For a manufacturer, an assessment of impacts on supply chain and operations can be used to support a whole-of-system approach to resilience.

Validating the model inputs with risk engineering

Going more in-depth to validate the physical climate change risk model inputs for critical assets, our risk engineering specialists can undertake site-specific surveys to better understand the business’ assets and vulnerabilities. More importantly, they can also identify any weak links (such as raised floor in flood-prone area) or assess the quality of controls in key locations, and provide practical resilience recommendations to enhance risk management approach.

Case study: A global financial institution

A global bank required an end-to-end climate risk management solution that included stress testing its mortgage-lending portfolio, assessing its own operational risks to climate change and integrating all findings into TCFD aligned reporting. Marsh conducted an analysis of about 100 global priority asset locations modelled against a multi-peril data set, with final recommendations based on inputs from supporting model providers. Assets were classified into risk categories from low risk to high risk, with Marsh conducting on-site risk engineering assessments for assets in the two highest-risk categories.

^[1] Extreme Weather Events Have Increased Significantly in the Last 20 Years. Yale Environment 360 (2020). https://e360.yale.edu/digest/extreme-weather-events-have-increased-significantly-in-the-last-20-years

^[2] Natural catastrophes in 2021: the floodgates are open. Swiss Re Institute (2022). https://www.swissre.com/dam/jcr:326182d5-d433-46b1-af36-06f2aedd9d9a/swiss-re-institute-sigma-natcat-2022.pdf

^[3] Natural Catastrophe Protection Gap in Asia Calls for Collaborative Innovation. Guy Carpenter (2022). https://www.guycarp.com/insights/2022/07/natural-catastrophe-protection-gap-in-asia-calls-for-collaborative-innovation.html