climate-insurance – Chasing Tales

Economic and financial impacts of climate change
First, some explanations. In climate change contexts, economists use “Economic Loss” to mean the total monetary impact on communities, sectors, or entire countries, including uninsured damages and broader ripple effects.¹ ² Economic loss is further divided into two types of loss, pure economic loss and consequential economic loss.

Pure Economic Loss is financial harm that occurs without any associated physical damage to property or persons, such as when bad weather warnings keeping people away from events they would otherwise pay to attend.³ ⁴ Consequential Economic Loss is loss that happens as a consequence of that physical impact, even if not immediately obvious, for example if excessive rains damage a local shop, which then has to shut shop for repairs compromising sales for the period.³ ⁴

These distinctions matter because even when it is not immediately evident, climate change drives losses through the economy in multiple ways large and small. Think of unemployment in a region due to a climate exacerbated disaster such as a forest fire which burns down parts of a town or a city, let’s say some warehouses or farms burn down, not only are assets lost in such cases, so is future consumption due to loss in employment income for those who worked in those warehouses or farms. Further, not every loss is or can be insured, but losses such as those caused by consumption loss after considerable climate disasters tend to have ripple effects across economies with no clear physical starting point.

Financial Loss refers to losses in actual money or other financial instruments (for example unencashed cheques lost in a flood event). It’s a more direct concept and includes only what can be counted.² ³

Understanding these terms helps us understand the following statistics a little better, while also realising that they can never grasp the full magnitude of climate damages.

Economic losses from natural disasters totalled $368 billion globally, driven by hurricanes, severe storms, and record heatwaves. As mentioned, the first half of 2025 is trending higher. In India, climate disasters cost India over $12 billion in 2025, with floods and heatwaves hitting agriculture and productivity especially hard.⁵ Projections show GDP per capita losses could reach 2.13% by 2025 and exceed 25% by 2100.⁵ Indeed, if global warming reaches 3°C by 2100, cumulative economic output could shrink by 15–34%. The net cost of inaction translates to a loss equivalent to three times current global health spending by 2100.⁶

Insuring against climate risks helps manage losses from climate change impacts such as extreme weather events, floods, droughts, and tropical cyclones, as well as more mundane events like too much or too little weather that affect economic performance, such as agricultural output, disrupted sports matches, rained in vacation seasons, and so on. The costs and frequency of extreme weather events have soared, with $100 billion in insured losses recorded in the first half of 2025 alone,⁷ ⁸ which is 40% higher than the same period in 2024 and more than double the 21st-century average⁷.

Term	What it Means in Practice
Pure Economic Loss	Financial hit without physical damage—like lost ticket sales because a bad weather warning kept customers away, even if nothing broke.
Consequential Economic Loss	Costs that ripple out from a disaster—like lost income when a business shuts for repairs, or when workers lose jobs after a factory burns.
Financial Loss	Tangible money lost—cheques that float away in a flood, crashed stock market values, or direct property damage costs.

In summary

Risk
The standard formula for risk is: Risk = Probability × Impact, where probability is the simple likelihood of an event happening, like we studied in school (here’s a post that talks about probability in deeper detail), and impact is how severe the consequences of the event would be, if it were to happen.⁹

In practice, insurers and climate researchers use risk matrices or quantitative models to assess and rank multiple risks in order of urgency, severity and other metrics. The formula for these kinds of advanced risk models can substitute “probability” with metrics like frequency, exposure, vulnerability, or asset value, and here the formula can change to something closer to: Risk = Threat Frequency × Vulnerability × Asset Value.⁹ ¹⁰

Financial institutions increasingly conduct climate stress tests to assess resilience under various climate scenarios. These tests measure CRISK, which measures the expected capital shortfall under climate stress scenarios, and functions similarly to financial crisis stress tests but incorporating climate risk factors.¹⁰ During the 2020 fossil fuel price collapse, major global banks experienced substantial CRISK increases; Citigroup’s climate-related capital shortfall rose by $73 billion in 2020 alone.¹⁰

Stress testing involves three steps: measuring climate risk factors (often using stranded asset portfolio returns as transition risk proxies), estimating time-varying climate betas for institutions, and computing capital shortfalls under stress scenarios.¹¹

DON’T PANIC HERE’S AN EXPLANATION: It’s like asking, if climate disasters happen, how much trouble would this bank be in? A stranded asset portfolio is the collection of companies that the bank is lending to, or whose stocks it owns, that would suffer most if the world suddenly got serious about fighting climate change. From this we subtract the returns of some regular stocks so that we can isolate the impacts of climate change. So let us say an extreme climate event happens, and this portfolio crashes by 50% in market value (market value is the value the portfolio assets would get if sold in the open market). Climate beta is a way to understand how much the bank’s own share price responds to climate events, or to governments cracking down on transition sensitive industries that it owns in the stranded asset portfolio. If a bank has lent lots of money to an oil and gas company, it will have a higher climate beta. We use the share price of the bank because it provides a real-time, market-based reflection of how investors perceive the bank’s overall financial health and risk exposure, including its sensitivity to climate-related events, making it a practical and observable indicator for assessing potential future losses and calculating stress test outcomes, which basically means that markets process information faster than accountants. Continuing with our example, let’s assume the bank has a climate beta of 0.6. In extreme climate stress (50% fossil fuel portfolio crash), this bank’s stock price would fall by 30% (0.6 × 50%). The final step is to understand, if the worst possible climate scenario happens, how much money would the bank need to stay afloat, for which the following formula can be used: Capital Shortfall = (Minimum Required Capital that a bank must maintain as mandated by the government) – (Bank’s Remaining Equity After Climate Shock).

Another example: Portfolio crash = 50%, climate beta = 1.2, therefore the bank’s stock price crashes by 60%. Now suppose the bank has total assets (the market value of the loans it has given out, the shares it owns, and any other assets) of $100, and the government has said that at the minimum it must have 10% of this amount with it at all times (the bank cannot use this money), so 10% of $100 is $10. Now let us say that the same bank had $40 in equity share capital, but because the price of this $40 crashed by 60%, it is now only worth 40% × $40 = $16. Since the $16 > the $10 the government said the bank must always have, this bank is safe. It is easy to see that banks that have different combinations of numbers will have different results.

Climate risk is not an abstract concept any longer simply because it is happening all around us, and we’re all suffering from it (and also because financiers have made formulae). Areas that suffer frequent climate impacts, whether (hehe, weather) direct or indirect are likely to suffer more financial consequences and have poorer asset protection since insurers would prefer to limit losses.¹² ¹³ It just so happens that these geographies are also the previously colonised Global South now suffering from the extended consequences of colonialism and the industrial revolution they did not partake in.¹⁴ ¹⁵

In 2023, the global insurance protection gap reached 67%- only 33% of $357 billion in economic losses from natural hazards were insured.¹⁶ This gap widens dramatically in developing countries, most of which are the historically colonised nations, where less than 10% of disaster losses have insurance coverage;⁵ Africa insures merely 0.5% of climate-related losses.¹⁷ Without intervention, uninsured global losses could double to $560 billion annually by 2030.¹⁶ Regions may become effectively “uninsurable” as coverage becomes inadequate, inaccessible, or prohibitively expensive.⁹ Another relevant stat: research indicates each 1% increase in insurance coverage moves countries 5.8% closer to achieving Sustainable Development Goals.¹⁸ ¹⁹ ²⁰

The protection gap stems from multiple factors:

Unaffordable premiums: Rising climate-related losses push insurers to increase premiums to reflect heightened risk, further widening affordability gaps and leaving many unprotected.²¹ ²²
Insufficient local risk data: In many emerging markets and developing economies, hazard maps and exposure data are incomplete, outdated, or inaccessible, limiting confidence in risk assessment tools and complicating underwriting decisions.²¹ ²³
Lack of government coordination across ministries: Fragmented policy frameworks, inadequate integration of disaster risk management with financial protection strategies, and limited inter-ministerial collaboration obstruct the scaling of insurance solutions and premium support schemes.²¹ ²⁴
Inadequate domestic financial sector development: In many emerging economies results in underdeveloped insurance markets, limited technical capacity among insurers and supervisors, low financial literacy, and weak distribution channels. These structural weaknesses restrict both the supply of insurance products and the demand from potential policyholders, perpetuating the protection gap.21 ²⁵

Types of climate risk²⁶
Climate risk refers to the potential negative impacts on society, ecosystems, or economies resulting from climate change. These risks are typically grouped into three main categories: physical risks, transition risks, and liability risks.

Physical Risks: These arise from the direct effects of climate change and are further divided into two subcategories:
- Acute physical risks are event-driven, such as hurricanes, floods, wildfires, tornadoes, heatwaves, or intense storms. These can cause sudden and severe damage to property, infrastructure, and supply chains.
- Chronic physical risks develop over a longer time frame. These include rising sea levels, gradual increases in average temperatures, changes in precipitation patterns, persistent droughts, land degradation, water scarcity, and ocean acidification.
Transition Risks: These are risks associated with the shift to a low-carbon economy and include challenges related to changes in policy, technology, market preferences, and investments. Examples include regulatory changes (carbon pricing, emissions limits), sudden shifts in market demand (e.g., decline in demand for fossil fuels), technological disruption (rapid adoption of renewables), or reputational damage if organisations are slow to adapt. Such changes may render some business models or assets less viable or even obsolete (these are called “stranded assets”).
Liability Risks: These stem from parties seeking compensation for losses they attribute to climate change. As regulatory requirements around disclosure and climate responsibility tighten, companies face increasing legal actions over failure to adequately manage or disclose climate risks, or for contributing to environmental harm.

More about stranded assets: To limit warming to 1.5°C, approximately 60% of oil and gas reserves and 90% of coal reserves must remain unburned, creating potentially $1.4 trillion in stranded fossil fuel assets globally.²⁷ Coal-fired power plants face the highest stranding risk, requiring retirement 10-30 years earlier than historical patterns to meet Paris Agreement targets.²⁸ Stranding extends beyond fossil fuels—aviation, heavy manufacturing, and carbon-intensive real estate also face obsolescence as the economy decarbonises. Physical climate risks like sea-level rise, floods, and droughts can also directly strand assets by making them uninhabitable or uneconomical. Buildings failing to meet emerging energy efficiency standards face early economic obsolescence, requiring costly retrofits or suffering reduced marketability.

The financial industry’s exposure to climate change¹⁰ ¹¹
The financial industry is exposed to climate risks on both sides.

In finance, buy side and sell side refer to the two broad categories of financial market participants and their roles in the investment ecosystem. The buy side includes entities whose primary role is to invest capital (money) for themselves or their clients, and their main goal is to generate positive returns from the purchase and management of these assets. Sell side entities provide investment products, research, and execution services to buy-side clients and often facilitate transactions between buyers and sellers.

Buy side entities face climate risk in the form of:
- Asset Value Declines: Physical climate events can damage or destroy underlying assets (like real estate, farmland, or infrastructure), eroding the value of investments.
- Transition Risks: As economies move to lower-carbon models, the value of companies or sectors exposed to fossil fuels, heavy industry, or outdated technologies may collapse, turning previously valuable holdings into “stranded assets”.
- Market Volatility: Unexpected regulatory policy, carbon pricing, or shifts in investor preferences can result in sharp drops in certain securities, particularly where climate risks were previously underpriced, or even unpriced.
- Reputational and Compliance Pressure: Asset managers are increasingly required to disclose their climate risk exposures, scenario analysis, and decarbonisation strategies under frameworks such as TCFD, EU taxonomy, and other local regulations.
And Sell side entities face them in the form of:
- Credit Risk and Loan Defaults: Borrowers struck by climate disasters (flood, drought, hurricane) may default on loans as asset values drop or cash flow dries up. Large-scale disasters can lead to significant concentrations of defaults in a short period.
- Collateral Devaluation: The value of physical collateral backing loans (properties, crops, factories) declines with repeated climate events or chronic risks such as sea-level rise or desertification.
- Underwriting Risk: Insurers see more frequent and severe claims for natural disasters, complicating pricing and threatening profitability.
- Rising Compliance and Capital Costs: Regulators increasingly require sell side firms to conduct climate stress tests, manage exposures, and allocate more capital against climate-vulnerable loans or portfolios (so that if their value suddenly declines, there is enough money to cover for it).

Some of the newer insurance instruments

Traditional vs. Parametric Insurance:¹⁰ Traditional indemnity insurance requires extensive damage assessment and claims verification, causing significant delays when communities need immediate relief. Parametric or index based insurance (called so because payouts are triggered by weather indices that measure heat waves, number of rainy days, wind speeds, etc.) trigger automatic payouts when predefined thresholds are met.

For example, if wind speeds in an area exceed 150 km/h, it may immediately send money to the people who are insured in that area, if rainfall below 200mm happens during growing season in an area, automatic payout will happen in that area, as long as data confirms that the threshold criteria were met. This brings transparency, expedites claims processing, and provides policyholders discretionary use of funds for their most urgent needs. Parametric insurance is also expanding to cover urban businesses, tourism, and logistics.

Catastrophe Bonds (CAT Bonds):²⁸ Catastrophe bonds are alternative risk transfer instruments that connect disaster risk to capital markets. Governments or corporations issue these high-yield debt securities through Special Purpose Vehicles, attracting investors including pension funds, asset managers, and hedge funds. Investors receive attractive returns—typically higher than traditional bonds—as long as specified catastrophes don’t occur. However, if predetermined triggers are met (a cyclone reaching specific intensity, earthquake exceeding certain magnitude, or insured losses surpassing threshold levels), investors forfeit some or all principal, which immediately transfers to the issuer for disaster relief and reconstruction.

The CAT bond market has grown substantially, reaching approximately $40-50 billion by 2025, up from minimal levels in the 1990s when they emerged after Hurricane Andrew devastated the insurance industry. India is exploring CAT bonds as the country faces $9-10 billion in annual disaster losses, with single events like the 2013 Uttarakhand floods causing over $6 billion in damages.

Risk Pooling Mechanisms:²⁹ ²⁶ Regional catastrophe risk pools aggregate disaster risks across multiple countries, exploiting geographic diversification where weather events affecting one nation are unlikely to simultaneously impact others. Research shows optimal regional pooling can increase risk diversification by 35-40% compared to individual country approaches. The three major global pools demonstrate this model’s effectiveness:

The Caribbean Catastrophe Risk Insurance Facility (CCRIF) covers tropical cyclones, earthquakes, and excess rainfall across Caribbean and Central American nations.
The African Risk Capacity (ARC) primarily addresses drought risk across African countries, with some coverage for other perils.
The Pacific Catastrophe Risk Insurance Company (PCRAFI) protects Pacific island nations against tropical cyclones and seismic risks.

These pools signed a Memorandum of Understanding at COP27 to collaborate on product development, advocacy, and capacity building.

Microinsurance for Climate Resilience:²⁹ Microinsurance extends risk coverage to low-income households in developing countries whose livelihoods are vulnerable to climate impacts. More than one billion unbanked adults live in the most climate-vulnerable countries, and they lack the financial resilience to withstand climate shocks.

Climate-linked index microinsurance products use satellite monitoring to trigger automatic payouts when drought, flood, or temperature indices reach predetermined levels, eliminating verification costs and fraud risks while providing rapid relief. Evidence suggests microinsurance helps vulnerable communities adopt risk management rather than harmful coping mechanisms after the events have happened, which then deepen poverty cycles.

Some microinsurance programs are now pairing parametric coverage against climate shocks with access to savings accounts or lines of credit accounts for post-disaster recovery. The idea is that this can strengthen community resilience.³⁰

Nature-Based Solutions and Insurance Innovation:⁵ Insurers increasingly recognise ecosystems2 as protective infrastructure deserving of coverage. Mangrove forests, coastal wetlands, and coral reefs provide natural storm surge barriers, while urban green spaces reduce flood risk and heat stress.

Insurance products now protect these natural assets and enable nature-based solutions, understanding that ecosystem degradation directly increases insured losses, although less than 2%²⁹ of international climate finance currently supports nature-based solutions for adaptation.

Instrument	What It Covers	How It Works	Who Uses It	Strengths	Challenges
Parametric Insurance	Weather extremes (rainfall, wind, drought, heat)	Policies pay out automatically if a set index (like rainfall, temperature) crosses a threshold—no need to prove physical loss	Farmers, governments, businesses in exposed areas, humanitarian agencies	Fast payouts, limited paperwork, works for hard-to-insure risks	May not match actual losses perfectly; needs reliable data
Traditional Insurance	Physical damage from weather/disaster	Payouts come after damage is verified, based on actual bills and assessments	Property owners, businesses, local governments	Familiar, covers wide loss types, can be customised	Slow response, costly verification, may not cover all gaps
Catastrophe Bonds (CAT Bonds)	Large-scale disasters (cyclones, earthquakes, floods)	Governments/businesses issue ‘high-yield’ bonds; investors lose their money only if disaster triggers payout	Countries, insurers, pension funds, asset managers	Brings capital markets into disaster relief, diversifies risk	Complex setup, investors risk losing principal if disaster strikes
Risk Pooling	Weather or disaster risks across regions or countries	Multiple countries/areas join a pool to share risks; one area hit, all pay, but events rarely hit all at once	Small nations, regional groups, insurance agencies	Reduces premiums, helps small countries access coverage	Governance is tricky, payouts depend on group solidarity
Microinsurance	Small losses for low-income, vulnerable groups	Ultra-affordable coverage, often parametric, sometimes bundled with savings, delivered by NGOs/banks/mobile	Farmers, informal workers, small businesses in climate hotspots	Swift and simple, increases resilience, avoids deep poverty	Can be less comprehensive, difficult to scale, requires outreach
Nature-Based/Ecosystem Insurance	Mangroves, reefs, wetlands, green urban assets	Policies protect/capitalise the restoration/maintenance of natural infrastructure	Coastal cities, local governments, conservation groups, insurers	Reduces cost of disasters naturally, preserves biodiversity	Not yet widespread, requires monitoring and valuation of natural assets

Comparable explanations of the different climate-related insurance products

In conclusion

As climate change intensifies, traditional insurance models face unprecedented challenges. Historical weather data, which is the foundation of actuarial science, becomes less reliable when climate patterns shift fundamentally.²⁶ Failure to manage climate risks exposes both buy and sell side firms to financial instability, reputational harm, and even legal action.

Financial institutions are adapting by increasingly adopting active risk management strategies that include scenario analysis, stress testing, enhanced data collection, and real-time monitoring of exposures to physical and transition risks, and by aligning governance structures, investing in climate modeling and reporting platforms, and embedding climate risk in all business decision layers including by setting climate-reduction targets, assessing financed emissions, and developing new risk-adjusted pricing and hedging strategies.

Sources

Tag: climate-insurance

Financing Climate Solutions IV: Insurance

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