Gimar special topic edition the impact of climate change on the financial stability of the insurance sector

 
2.1 FINANCIAL IMPACT OF CLIMATE 
CHANGE ON INSURERS’ ASSETS
Existing literature already investigates channels by 
which climate-related shocks might be transmitted 
through and amplified by the financial system (see 
FSB (2020)). The manifestation both of physical 
risks and of a disorderly transition towards a 
low-carbon economy could affect insurers’ asset 
portfolios, although the timing of such impacts is 
uncertain and may differ. Transition risks affecting 
financial stability could appear in the near term, 
particularly if policies towards a net-zero emissions 
economy are accelerated. By contrast, physical 
risks are unlikely to lead to financial stability 
concerns in the short or medium term.
Focusing on insurers’ assets, financial risks 
may materialise in different risk dimensions with 
potential financial stability consequences. There 
are also important second-round and spillover 
effects within the financial system that may amplify 
the effect of climate-related risks.
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Examples of 
a possible split along four risk dimensions and 
related spillover effects are provided below.
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Credit risk: 
Sectors exposed to climate-related 
risks may suffer losses when they are unable to 
effectively manage transition risk. Climate-related 
risks can thus induce, through direct or indirect 
exposure, a deterioration in borrowers’ capacity 
to generate sufficient income, as it might lead to 
higher probabilities of default in:
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carbon intensive industries (stranded assets); 
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investments in technologies that turn out to be
less promising than expected or superseded
by new technologies.
This would affect the creditworthiness of these 
borrowers, and ultimately affect bond prices 
or cause yield shocks. Moreover, the potential 
depreciation of assets used for collateral (eg lower 
value of real estate due to policy changes) can 
also contribute to higher credit risk.
In terms of physical risk, an example would be if the 
destruction of a production site due to an extreme 
weather-related event increases the probability of 
default of the company operating the site.