Aon  |  Financial Institutions Practice
Climate Risk

Ecosystems and economies are exposed to volatile climate change risks, creating an unstable operational and regulatory environment for financial institutions.

To navigate volatile climate risk, financial institutions must execute two core objectives:

  • 1. Manage the firm’s own financial exposures
  • 2. Support the global green agenda, which will be critical to mitigate the long-term impact of global warming

With the ramifications of the COVID-19 pandemic still playing out, focus on tail risk has accelerated and expectations from investors, regulators and stakeholders on climate have increased. They fully expect financial institutions to be able to quantify, disclose, risk manage and adapt corporate strategy to account for climate risk.

Managing the firm’s own financial exposures

In the insurance sector, underwriting guidelines, pricing, and portfolio allocations historically have been driven by catastrophe models. Although these models provide near-term insights into the physical risks arising from climate change – including the ability to assess vulnerabilities at an individual asset level – these models rely almost exclusively on historical data to predict losses from catastrophe risk, meaning they are reliable indicators of near-term physical risk, but struggle to establish a long-term view of climate change risk.

Catastrophe models have become the language of risk transfer for climate-related risks in banking and asset management and will continue to drive pricing allocation and capacity. By integrating insights from global climate models – which predict the forward-looking impact of various carbon emissions on global mean temperature at a continental level – financial institutions can demonstrate a more robust, backward- and forward- looking framework for climate risk management to insurers and stakeholders.

This emerging model set demands a combination of qualitative and quantitative analysis. Access to the tools and expertise to perform both the quantitative analysis and qualitative overlay on catastrophe and climate models is critical to enable financial institutions to better understand the challenges and opportunities that climate change may bring to the firm.

Supporting the green agenda – an ESG imperative

Clients across the real estate, agribusiness and oil and gas industries are facing immediate and long-term challenges, which could potentially leave financial institutions’ balance sheets at risk.

Global temperatures continue to rise and it is incumbent on banks not only to manage the subsequent risks to the firm and their clients, but to identify opportunities to finance projects which tackle climate change across multiple industries.

By lending into industries which are actively engaged in tackling climate change – such as transforming polluting oil and gas to renewable processes, refurbishing plants to avoid or capture carbon, or supporting the automotive, logistics and transportation industries shift towards electric technologies – financial institutions can take an active role in managing climate risk for individuals and businesses, globally.

Integrating climate risk into the broader risk management framework demands specialist expertise to translate qualitative data and qualitative insights into an actionable strategy.