How Companies Are Using Climate Modeling to Improve Risk Decisions

How Companies Are Using Climate Modeling to Improve Risk Decisions
Weather

09 of 12

This insight is part 09 of 12 in this Collection.

September 20, 2023 6 mins

How Companies Are Using Climate Modeling to Improve Risk Decisions

How Companies Are Using Climate Modeling to Improve Risk Decisions Hero image

Climate modeling has been around for decades but mainly used by academic and government scientists. Led by the risk industry, the private sector is adapting these models to broadly assess the physical impacts of climate change.

Key Takeaways
  1. Climate risk models offer a crucial opportunity to go beyond a historical view of risk to adequately assess, quantify and mitigate the impacts of climate change.
  2. They are built to be forward-looking, by incorporating predictive climate science into a risk modeling framework.
  3. Despite their potential, users of climate risk models need to be aware of the possible sources of uncertainty in these tools.

Public awareness and regulatory pressure have created demand for climate modeling to help organizations understand changing risk, build resiliency and respond to disclosure requirements.

Climate modeling has been around for many decades but mainly used by academic and government scientists. Now, the private sector — driven by the risk industry — is adapting these models to broadly assess the physical impacts of climate change.

In this article, we explain what climate modeling is today and how these insights can be applied by organizations.

What Are Climate Risk Models?

Climate risk models have recently emerged to serve the need for relevant and accessible climate information at a level that is appropriate for decision makers across a wide range of industry sectors including financial services, insurance, agriculture, real estate, and others. Consider securing a mortgage for your home as an example. A potential impact of climate change on the mortgage industry is increased credit default rates. Climate risk models can help quantify risks that could materialize over a 30-year mortgage. A coastal home financed today could be untenable in the future due to sea level rise.

Unlike traditional catastrophe models, which often leverage historical data to identify near-term risk, climate risk models are designed to be forward looking, explicitly incorporating predictive climate science into a risk modeling framework. Their goal is to quantify the probability of costly but rare events — and their underling sensitivity to climate change — in a physically consistent way.

Translating Scientific Climate Modeling to Risk Applications

Global climate models, or GCMs, are typically the primary source of climate information that underpins climate risk models. A GCM is a state-of-the-art numerical model that simulates the physical processes and interactions between the atmosphere, ocean, ice and land surfaces that are relevant to the climate system using the latest scientific understanding and technical capabilities.

GCMs are developed in the public sector by large teams of scientists and engineers at major laboratories and universities across the world. Curation and dissemination of GCM data is coordinated under the World Meteorological Organization, World Climate Research Programme and Coupled Model Intercomparison Project. The results help inform the United Nation’s Intergovernmental Panel on Climate Change (IPCC) assessment reports.

A central purpose of GCMs is to understand how the climate system responds to various greenhouse gas (GHG) emissions. Since future GHG emissions are inherently uncertain, a range of trajectories, known as shared socioeconomic pathways, are used to bound the uncertainty surrounding future societal development. This immense undertaking translates into a wealth of climate change information made freely available to the public for download and exploration. While excellent resources, the information provided is not necessarily useful for an end-user yet. At this stage, the data is at a scale far too coarse to adequately inform physical risk assessment for many high-impact phenomena like tropical cyclones. This is where climate risk modeling comes in.

How Are Climate Risk Models Developed?

Downscaling or refining the GCM data is the first step in making climate model projections suitable for quantifying risk. This is the process of taking the large-scale climate models and making them fit-for-purpose at a local level for analysis and planning.

This process typically falls into two broad categories: statistical and dynamical, each with their own tradeoffs:

  • Statistical downscaling builds relationships between historical observations at small scales and GCM output at coarse scales. It is computationally efficient but requires high quality observations and makes assumptions that may be unrealistic in the future.
  • Dynamical downscaling uses coarse GCM outputs to drive higher resolution regional climate models. It is physically more realistic but very expensive to implement, limiting its feasibility for widescale usage.

The next step is calculating relevant peril metrics from the downscaled climate model data. This can take many forms depending on the data provider or peril of interest, but generally includes some form of extreme value analysis to estimate the tail behavior of extreme weather phenomena under a changing climate.

Once relevant hazard metrics are calculated from downscaled climate models, the data can be fed into subsequent vulnerability models to explicitly quantify the financial impacts of climate change. In this way, climate risk models can sometimes blend aspects of catastrophe modeling with hazard information derived from GCMs.

Why Are Climate Risk Models So Important Today?

Risk managers need to move beyond a purely historical view of risk to adequately quantify the potential impacts of climate change. This is no small feat and requires bringing public sector climate modeling and private sector catastrophe modeling closer together.

Climate risk models offer significant potential but are not without their own shortcomings. Decision makers need to be cognizant of new sources of uncertainty endemic to this type of modeling. This includes uncertainty around which GCMs and scenarios to use, as well as limitations of the underlying downscaling method. Climate data providers, in turn, should be transparent in quantifying and conveying such information.

How to Approach Climate Modeling: 3 Ways to Start

Effectively leveraging climate risk modeling into an overall risk management framework is a journey. Start by truly understanding and outlining your organization’s climate risk program needs to:

  • Cultivate a holistic view of physical risk where climate modeling is one part of a broader toolkit.
  • Identify business use cases to determine the appropriate scope and depth of climate data needed.
  • Choose data partners with transparent and sound approaches, pairing the latest scientific research with customized business solutions.

General Disclaimer

This document is not intended to address any specific situation or to provide legal, regulatory, financial, or other advice. While care has been taken in the production of this document, Aon does not warrant, represent or guarantee the accuracy, adequacy, completeness or fitness for any purpose of the document or any part of it and can accept no liability for any loss incurred in any way by any person who may rely on it. Any recipient shall be responsible for the use to which it puts this document. This document has been compiled using information available to us up to its date of publication and is subject to any qualifications made in the document.

Terms of Use

The contents herein may not be reproduced, reused, reprinted or redistributed without the expressed written consent of Aon, unless otherwise authorized by Aon. To use information contained herein, please write to our team.

Aon's Better Being Podcast

Our Better Being podcast series, hosted by Aon Chief Wellbeing Officer Rachel Fellowes, explores wellbeing strategies and resilience. This season we cover human sustainability, kindness in the workplace, how to measure wellbeing, managing grief and more.

Aon Insights Series Asia

Expert Views on Today's Risk Capital and Human Capital Issues

Aon Insights Series Pacific

Expert Views on Today's Risk Capital and Human Capital Issues

Aon Insights Series UK

Expert Views on Today's Risk Capital and Human Capital Issues

Client Trends 2025

Better Decisions Across Interconnected Risk and People Issues.

Construction and Infrastructure

The construction industry is under pressure from interconnected risks and notable macroeconomic developments. Learn how your organization can benefit from construction insurance and risk management.

Cyber Labs

Stay in the loop on today's most pressing cyber security matters.

Cyber Resilience

Our Cyber Resilience collection gives you access to Aon’s latest insights on the evolving landscape of cyber threats and risk mitigation measures. Reach out to our experts to discuss how to make the right decisions to strengthen your organization’s cyber resilience.

Employee Wellbeing

Our Employee Wellbeing collection gives you access to the latest insights from Aon's human capital team. You can also reach out to the team at any time for assistance with your employee wellbeing needs.

Environmental, Social and Governance Insights

Explore Aon's latest environmental social and governance (ESG) insights.

Q4 2023 Global Insurance Market Insights

Our Global Insurance Market Insights highlight insurance market trends across pricing, capacity, underwriting, limits, deductibles and coverages.

Regional Results

How do the top risks on business leaders’ minds differ by region and how can these risks be mitigated? Explore the regional results to learn more.

Human Capital Analytics

Our Human Capital Analytics collection gives you access to the latest insights from Aon's human capital team. Contact us to learn how Aon’s analytics capabilities helps organizations make better workforce decisions.

Human Capital Quarterly Insights Briefs

Read our collection of human capital articles that explore in depth hot topics for HR and risk professionals, including using data and analytics to measure total rewards programs, how HR and finance can better partner and the impact AI will have on the workforce.

Insights for HR

Explore our hand-picked insights for human resources professionals.

Workforce

Our Workforce Collection provides access to the latest insights from Aon’s Human Capital team on topics ranging from health and benefits, retirement and talent practices. You can reach out to our team at any time to learn how we can help address emerging workforce challenges.

Mergers and Acquisitions

Our Mergers and Acquisitions (M&A) collection gives you access to the latest insights from Aon's thought leaders to help dealmakers make better decisions. Explore our latest insights and reach out to the team at any time for assistance with transaction challenges and opportunities.

Natural Resources and Energy Transition

The challenges in adopting renewable energy are changing with technological advancements, increasing market competition and numerous financial support mechanisms. Learn how your organization can benefit from our renewables solutions. 

Navigating Volatility

How do businesses navigate their way through new forms of volatility and make decisions that protect and grow their organizations?

Parametric Insurance

Our Parametric Insurance Collection provides ways your organization can benefit from this simple, straightforward and fast-paying risk transfer solution. Reach out to learn how we can help you make better decisions to manage your catastrophe exposures and near-term volatility.

Pay Transparency and Equity

Our Pay Transparency and Equity collection gives you access to the latest insights from Aon's human capital team on topics ranging from pay equity to diversity, equity and inclusion. Contact us to learn how we can help your organization address these issues.

Property Risk Management

Forecasters are predicting an extremely active 2024 Atlantic hurricane season. Take measures to build resilience to mitigate risk for hurricane-prone properties.

Technology

Our Technology Collection provides access to the latest insights from Aon's thought leaders on navigating the evolving risks and opportunities of technology. Reach out to the team to learn how we can help you use technology to make better decisions for the future.

Top 10 Global Risks

Trade, technology, weather and workforce stability are the central forces in today’s risk landscape.

Trade

Our Trade Collection gives you access to the latest insights from Aon's thought leaders on navigating the evolving risks and opportunities for international business. Reach out to our team to understand how to make better decisions around macro trends and why they matter to businesses.

Weather

With a changing climate, organizations in all sectors will need to protect their people and physical assets, reduce their carbon footprint, and invest in new solutions to thrive. Our Weather Collection provides you with critical insights to be prepared.

Workforce Resilience

Our Workforce Resilience collection gives you access to the latest insights from Aon's Human Capital team. You can reach out to the team at any time for questions about how we can assess gaps and help build a more resilience workforce.

More Like This

View All