Bert Kramer, head of climate research and climate and ESG Solutions at Ortec Finance, explains how the risk and financial modeller can help insurers' investment teams deal with the complexities of climate risk
How can Ortec Finance help insurers to quantify their portfolios' financial exposure to climate risks and opportunities?
Climate change is an increasingly important and complex risk factor that has a potential impact on every step of the investment decision process. Results and insights from climate risk analysis are increasingly combined and integrated with traditional investment risk analysis to drive investment decision making. Ortec Finance offers a combination of solutions that help investors to integrate climate change into their decision making in a consistent and seamless way.
The preferred approach of Ortec Finance, to support investment decision making and to prepare for the future, is to combine results and insights from realistic stochastic scenarios with results and insights from carefully constructed deterministic, narrative based, climate scenarios.
Stochastic scenarios are used to support risk-return trade-offs and for sensitivity analyses. Deterministic scenarios are used to obtain detailed insights and for stress testing purposes. Deterministic scenarios are particularly useful in situations of great uncertainty and complexity, as is exactly the case for climate change.
How has Ortec Finance developed its climate risk solutions over the past year? What new innovations is Ortec Finance planning in this area for 2024?
Ortec Finance started building and applying climate scenarios more than 5 years ago. The Ortec Finance Climate Scenarios are improved and updated in an annual release cycle to reflect the latest research and insights.
In the 2024 release, we have incorporated the effects of recently announced and implemented policies and included the potential impact of tipping points in our high warming scenario.
We have also added a new delayed net zero scenario that reaches just below 2 degrees warming by 2100 and incorporated the impact of new technologies like hydrogen and land-use change.
In addition, we have expanded our range of sensitivity analyses, particularly in relation to physical risks (e.g. tipping points, ENSO effects, different damage functions).
Amongst others, we have introduced a high warming stress scenario where the physical risk impact estimates are in line with the most severe damage function proposed in the IFoA report 'The Emperor's New Climate Scenarios': the Logistic 4C damage function. Finally, in 2024 we are launching an extensive climate scenario explorer dashboard.
In this rapidly evolving field, we find topics like disruptive climate scenarios, where the disruption is not only on financial markets via pricing-in / stranded asset shocks, but also in the real economy.
Other important topics incorporate biodiversity and other nature-related risks.
Why should insurers come to Ortec Finance for climate risk solutions?
The Ortec Finance Climate Scenarios enable insurers to quantify their portfolio's exposure to systemic climate-related financial risks and opportunities. The Ortec Finance Climate Scenarios offer full climate risk coverage — explicitly modelling extreme and long-term physical, transition, and market risks.
Our scenarios offer both sophistication and transparency in the climate modeling space, which is increasingly being 'black boxed'. Compared to other scenario analysis products available to insurers, the Ortec Finance Climate Scenarios:
- Capture the networked effects of climate change, interconnections, and feedback loops. Whereas most other models proxy all transition risk using carbon price, by explicitly modelling 20+ distinct climate policies, the Ortec Finance Climate Scenarios can tie together how the global economy will be impacted by climate change from a top-down perspective that other models understate.
- We provide a robust set of climate scenarios and offer highly granular sector and region coverage of over 600 sector-region combinations.
- Ortec Finance explicitly (and separately) models chronic physical and acute (extreme weather) risks, with the ability to disentangle the contribution of transition, chronic physical, and acute physical risks from one another.
- We use non-linear damage functions for both acute and chronic physical risks, leading to very severe physical risk impacts, in contrast to most other scenario providers (incl. NGFS), that use damage functions that result in relatively small chronic physical risk impacts and largely ignore acute physical risk impacts.
- Our tools can be used in a consistent and seamless manner, together with the stochastic scenarios from the Ortec Finance Economic Scenario Generator, to support investment decision making and risk management.
