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There are three kinds of financial risk caused by climate change: physical, transition and liability risk. Physical risk has two forms: chronic and acute, where chronic refers to steady changes in climate patterns and acute refers to the increased frequency and severity of extreme climatic events such as hurricanes and floods.
Insurers use cat models to estimate the potential losses due to natural disasters. It is essential that such models account for the climate change that has already occurred. Model vendors can use various techniques to do this. Historical data can be preferentially weighted to more recent years, the data can be de-trended or a more recent period of historical data can be used.
Firms need to consider the possible effects of climate change in the long term too. Horizon scanning and scenario analyses are essential here. New tools are now available to help firms quantify acute physical risk. Insurers now have access to climate change conditioned catalogues and climate change event sets that answer ‘what if’ questions. Beyond insurance, firms can access supply chain models and work with model vendors to measure their acute physical risk from global supply chains.