Climate change poses many financial risks, from increasing disaster costs to reduced economic growth. Regulators and financial institutions need more data, analysis tools, and resources in order to assess these risks more accurately and incorporate them into their decisions.
Asset location can also play an integral part in their vulnerability to climate hazards, which may result in losses to assets and compromise financial stability.
Households
Climate change impacts can create hidden vulnerabilities in financial markets and increase overall systemic risk, whether through losses to levered financial intermediaries, disruption in market functioning or sudden repricing of large classes of assets.
Individual household finances may become fragile as climate hazards raise consumer prices for energy, water, food and transportation services, increasing energy and transportation costs as a result of climate hazards. Furthermore, extended time away from work due to climate disasters can reduce incomes while eliminating access to employer benefits like health insurance or retirement savings.
Successful mitigation and adaptation efforts could decrease future disaster costs, yet their upfront costs might not produce savings in the same way that investments do. For instance, investing money into elevating flood-prone homes might incur costs to federal programs that provide support for military bases, infrastructure as well as housing repair assistance or weatherization assistance programs.
Businesses
Businesses are susceptible to numerous climate change risks. These may range from physical changes like severe weather-related property damage, disruption of supply chains due to inaccessible or disrupted shipping routes, drought conditions causing water scarcity as well as financial threats such as higher default rates in loan portfolios or decreasing asset values as a result of rising sea levels.
Climate change offers businesses many opportunities for growth by adopting more sustainable business practices. Reducing emissions through renewable energy sources or designing products with positive carbon footprints through their life cycles can reduce cost and increase profits, with businesses reaping benefits both economically and environmentally.
Companies can utilize new technologies that help them produce more with less. This may require switching towards less carbon-intensive raw materials or processes or moving toward energy efficient cars and buildings; but more must be done than just increasing management disclosures and setting environmental risk assessments and targets.
Government
Governments face climate-related financial risk from physical damage, reduced revenue due to decreased goods and services demand, or higher disaster assistance program expenses. Households also risk experiencing financial stress as utility expenses such as air conditioning and heating rise due to climate change; governments are working on ways to address these risks through energy assistance for low-income households, public cooling centers during heat waves, etc.
Mitigation and adaptation efforts can be seen as investments; they involve upfront costs with the expectation that harmful climate change effects will be prevented. Over time, these activities should yield budgetary savings; though CBO does not currently have a basis for estimating them due to additional information and analysis needed; some savings may even offset up-front costs incurred by federal agencies or nonfederal parties – sometimes called moral hazard arrangements.
Insurers
As climate change alters risk landscapes, insurers will need to review their practices. They will have to reexamine policies and procedures – including any catastrophe modeling programs they use – as well as considering its effect on overall economy.
Climate change will likely wreak havoc on insurers over time and cost trillions. Losses could occur through direct losses from natural disasters as well as transition risks arising from repricing brown assets.
California wildfires that led to PG&E’s bankruptcy triggered multiple forms of risk – credit, market, operational and reputational. This wide array of impacts serves to illustrate the difficulty involved with managing and pricing climate change risks. Historic statistics become less applicable; insurers will need to use forward-looking models and simulations instead to assess risk levels; this in turn affects underwriting decisions as well as rate setting processes while simultaneously contributing to sustainable reinsurance coverage.