Article: Managing Risk in a More Complex World

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19/01/2023

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Key takeaways

  • Financial decisions today do not account for physical risks from climate change or adequately support climate resilient development.
  • The insurance industry can catalyse resilient investment through risk transfer, risk signals and its own portfolios.
  • A common language of risk is essential to align finance and resilience, and partnerships between insurance and research are key to developing this.

Article

This article was featured as the foreword to an essay compendium for the Allianz Climate Risk Award 2022. 

The nature of risk is evolving; climate change, biodiversity loss and our more interconnected economies mean that our economies face new risks that are more severe and complex and have longer- lasting impacts on our societies. Our approaches to understanding risk need to evolve in line with this, but so must our approaches to managing risk. There is no one silver bullet solution but finance must play a crucial role. The financial decisions taken today can shape the structures of our economies over decades. While action is advancing to align financial flows with our ambition to limit global temperature rise to 1.5C, we are a long way from aligning our financial system with our resilience goals. I argue firstly that insurance and risk financing can play a critical role in helping to ensure that finance works for societal resilience rather than against it; and secondly, that to align finance with resilience we need a common language of risk as a foundation for action.

We need to aim for 1.5C but plan for 3C. Even if we take the most optimistic view of current government pledges, global temperatures are expected to rise by around 1.8C this century. If we look only at real-world action based on current policies, this would increase to 2.7C (2.2 – 3.4C with uncertainties). This level of warming will lead to structural shifts in our economies and major changes to the global risk landscape, putting people at growing risk.

"Insurance is essential to protect people and economies. But importantly, it can also help to unlock the investment needed in adaptation through providing an important risk signal across the wider economy"

Financial decisions today impact on societal risks for decades; yet do not account for these climate-related physical risks. For example, around 2.7 trillion per year is invested globally in infrastructure yet much of this without meeting basic resilience standards. Nearly half of the FTSE 100 index companies rely upon supply chains that are exposed to droughts, floods and water scarcity. Yet, the 2022 progress report of the Task Force for Climate-related Financial Disclosures (TCFD) showed that physical climate risks are still underpriced across the financial system. Article 2.1c of the Paris Agreement called for finance to be aligned with climate resilient development; but the evidence clearly shows that this is not happening in practice. Even looking at government expenditure, recent research by the University of Oxford shows as much as 30% may be in areas that could be maladaptive.

Insurance and risk financing can play a crucial role in helping finance and investment – public and private – to align with societal resilience goals. Firstly, through its traditional risk transfer role, insurance is essential to protect people and economies. But importantly, it can also help to unlock the investment needed in adaptation through providing an important risk signal across the wider economy and financial system that can act as an economic incentive for action. The industry can play a key role in catalysing resilient investment directly through its own investment portfolios and through its relationships with its clients and governments. For emerging and developing economies, insurance also plays a crucial role in mobilizing investment for mitigation and adaptation through de-risking.

"The financial decisions taken today can shape the structures of our economies over decades. While action is advancing...we are a long way from aligning our financial system with our resilience goals"

To empower insurance as such a resilience catalyst, and support the wider alignment of finance with resilience, the world needs a common language of risk. At the University of Oxford, in partnership with the Insurance Development Forum and international partners, we have been working toward the development of the world’s first fully open and globally consistent risk dataset, the Global Resilience Index Initiative.

This open climate risk data architecture – launched at COP27 – aims to help level the playing field in risk understanding and enable new financial solutions for resilience. We draw upon the best science from around the world and aim to put this to work to support global resilience. Our partnership with the insurance industry is key to the success of GRII, enabling us to draw upon the world-leading risk knowledge of the industry. For this reason, we applaud the work of Allianz Reinsurance to advance risk knowledge through the Allianz Climate Risk Award.

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