Uninsurability and repricing of risk – climate tipping points as a critical factor for the economy and financial system

Global warming and the approaching critical climate tipping points are having a drastic impact on the planet's climate. “This massive change is causing increasing climate damage, which is not only affecting the environment and society, but also, to an increasing extent, national economies and financial systems,” says Dr. Heinz-Werner Rapp, founder and director of the FERI Cognitive Finance Institute. In its latest analysis, “Uninsurability and Repricing of Risk: Climate Tipping Points as a Critical Factor for the Economy and Financial Systems”, the institute examines the consequences of accelerated climate change and its implications for the global economy, the financial industry, and capital markets.

Climate risks become financial risks

Large parts of the financial system are directly or indirectly affected by rising climate risks, primarily due to rapidly increasing costs. Although the issue is now also the focus of regulatory authorities such as the ECB, “many market participants still seem to be largely ignoring or even dismissing the problem,” says Rapp. Climate-related risks are already uninsurable in exposed regions, and there is also a risk that insurance risk exclusions will spread to other areas of the financial system. The accumulation and concentration of financial climate risks and increasing protection gaps increase the likelihood of systemic crises in credit and capital markets in the medium term.

Completely new concepts are needed to better manage such risks: “In order to mitigate the problem of insufficient risk perception and quantification, special risk metrics must be developed – concepts such as ‘planetary solvency’ are examples of this,” says Rapp. A more realistic risk assessment is needed on the capital markets, i.e., a general repricing of risk. However, with climate tipping points looming ever closer, time for effective action is running out.

Financial markets must adequately price in rising climate risks

Rapidly advancing climate change will bring a host of new challenges in the coming years. “Above all, market participants must understand that climate risks are financial risks,” emphasizes Rapp. However, this issue has often not yet really reached the global capital markets or been adequately priced in, and suitable models for analyzing and managing nonlinear climate risks are often lacking. From a political perspective, the targeted development of climate resilience is essential—for example, by adapting infrastructure and establishing effective early warning systems. “It is therefore clear that the reassessment of systemic climate risks will be a determining factor in the coming years,” explains Rapp. Entrepreneurs and professional investors are called upon to recognize this fundamental change in good time and to take it into account in the form of appropriately adjusted risk perception.

In its new Cognitive Comment entitled “Uninsurability and repricing of risk: climate tipping points as a critical factor for the economy and financial systems”, the think tank of the Bad Homburg-based FERI Group analyzes the potential consequences of accelerated climate change for the economy and capital markets. The analysis is available in German for download.