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Risk & Compliance

Leveraging Catastrophe Risk Models to Assess Climate Risk

As climate and environmental reporting and disclosure requirements have only intensified amid the broader ESG movement, companies can leverage catastrophe (cat) risk models to assist in assessing a critical aspect of climate risk.

Recent serious weather events, from record-cold temperatures in Texas to wildfires and floods in Australia, have devastated local communities, elevating the importance of understanding climate risk not only for the region but also for businesses in the area. As climate and environmental reporting and disclosure requirements have only intensified amid the broader ESG movement, companies can leverage catastrophe (cat) risk models to assist in assessing a critical aspect of climate risk.

“Reporting and disclosure requirements are increasing—I don’t think that’s controversial, but I do think that means we need to use whatever tools can help us meet those requirements. I think that catastrophe models are a useful tool that can help us meet some of these requirements,” Matt Jones, head of Catastrophe Risk Products at Nasdaq, said during The Economist’s virtual Climate Risk Summit: North America.

Jones noted how several organizations are leading climate reporting and disclosure requirements, including the Task Force on Climate-Related Financial Disclosures (TCFD) and the Network for Greening the Financial System (NGFS). There are also country-specific initiatives, such as the Australia Climate Measure Standards Initiative (CMSI) and the U.K. Bank of England 2021 Biennial Exploratory Scenario (BES) – the latter of which will look at how climate change risk stresses not only the banks and insurers but also the broader U.K. financial systems. While there is an increasing number of reporting and disclosure requirements, Jones acknowledged that they often differ in terms of time periods and scenarios or variables required.

When evaluating climate risk, Jones outlined the three categories companies should be considering: Liability, transition and physical. “Liability risk is simply the risk of litigation from climate-related impact,” Jones stated, whereas transition risk is the risk that emerges from moving to a low-carbon economy and the implications to a business’s products or services. Physical risk, on the other hand, relates to the risk from physical events, such as storms, floods, droughts and rising sea levels.

“Cat risk models are useful tools to help us understand physical climate risk,” Jones said.

Catastrophe risk models have been around for about three decades, focused heavily on the insurance and reinsurance markets. In today’s environment, however, Jones believes that “these models can serve a much wider community now and in the future as there’s a much wider community seeking to understand the impact of climate risks.”

As Jones explained, cat risk models help quantify large-scale event risk by quantifying how risk at a given location is linked to risk at other locations. More recently, climate-conditioned cat models have emerged to better estimate future risk. While most current climate-conditioned cat models typically focus on changes in the hazardous weather event, such as flooding or wildfires, Jones expects additional climate-conditioned models and capabilities to arise.

With more climate-conditioned cat models expected to come to market, Jones emphasized how open-source technology and cloud-based software can accelerate growth, removing traditional barriers to model access and enabling a wider range of models to be used at a lower cost.

Nasdaq’s Risk Modelling for Catastrophes platform, previously known as ModEx, is the first independent multi-vendor cat risk modelling platform for the re/insurance industry. Powered by the Oasis Loss Modelling Framework and delivered as a service, it offers a new and cost-effective way for firms to meet their modelling requirements. By working with 12 model vendors, Nasdaq’s platform provides insights into more than 300 country-perils globally.

“Climate change reporting requirements are increasing, and we need to use all the tools we can, and cat models are a very useful tool to help us identify climate-related risks now, but also help us quantify a future risk from climate change,” Jones concluded.

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