Strategic Insights
June 7, 2019

Off-The-Books Climate Risks: The Next Financial Crisis?
 

The macro risks of climate change are increasingly clear, but business and investor accounting for future liabilities and costs are in their infancy.

• CSIS’s Sarah Ladislaw: “Recognition of climate risks appears to be growing but careful study of how companies and asset classes might be effected by those impacts are lagging behind where they need to be.”
• A recent study from the London School of Economics estimates that, conservatively, $2.5 trillion, and potentially up to $24.2 trillion, in present market value of global financial assets are at risk due to climate impacts.
• With so much unpriced risk on the market, a devastating natural disaster in one region could have significant ripple effects through the global economy, possibly triggering the next global financial crisis.

Climate change-linked physical damage and supply chain disruptions are on an increasing trend line.

• The annual number of extreme weather events has tripled since 1980, costing the United States a total of over $1.6 trillion to date.
• Climate change is already adding a drag to economic growth, with worsening hurricanes alone trimming U.S. GDP by 0.3 percent annually.
• The annual global cost of natural disasters averaged $140 billion between 1980-2017, but it has risen above that in 7 of the past 10 years. In 2018 in the United States alone natural disasters cost $91 billion.
• CDP, an NGO focused on climate risks, reports that 215 of the world’s 500 largest corporations face about $1 trillion in climate-related costs, most of which could materialize over the next five years.

• In 2011, over 14,500 companies, including major multinationals such as Toyota and HP, suffered business disruptions and incurred up to $20 billion in insured losses as severe flooding hit operations and assets in Thailand.
• In 2017, Hurricane Maria hit U.S. pharmaceutical company Eli Lilly’s manufacturing facilities and triggered U.S. supply shortages.
• This year, floods in the U.S. Midwest are devastating agricultural output, and a drought crippling the movement of raw and manufactured goods along the Rhine River has likely pushed Germany into recession.

• Current global infrastructure, including energy and transportation networks, was designed according to historical weather data without consideration for climate change.
• While more resilient building standards are slowly spreading, climate-proof construction adds costs.
• This risk relates directly to critical infrastructure in the United States (especially in energy and shipping), which is highly clustered in vulnerable coastal areas such as the U.S. Gulf Coast.
• Reconstructing and reinforcing Puerto Rico’s energy grid after Hurricane Maria is estimated to cost $17.6 billion, and the U.S. government expects climate change-related inland flooding to inflict $1.2-1.4 billion each year in damages to bridges alone by 2050.

• In 2017 and 2018, the insured losses of natural catastrophes amounted to $219 billion around the world—the highest total of any recorded two-year period. Globally, average annual insured losses from extreme weather increased by 138% between 1980 and 2017.
• According to the International Association of Insurance Supervisors, “If not adequately considered across sectors, disruption to financial markets stemming from climate risk could affect reserving decisions, capacity to satisfy liabilities, and ultimately impact solvency.”
• Consider just one recent example: Merced Property & Casualty Co. was forced to liquidate after the 2018 Camp Fire destroyed Paradise, California and saddled it with about $64 million in outstanding liabilities.

• U.S. private and federal insurance generally covers just 40 percent of losses to the commercial sector. 
• While federal and state governments may provide aid, local communities often face a post-disaster collapse in local real estate values leading to the erasure of household equity, bankruptcy, and delinquency and default in business and housing loans.
• Uninsured losses are rising more quickly than insured losses: last year, $80 billion in economic losses from natural disasters were uninsured and incurred directly by local communities and businesses.
• Following Hurricane Harvey in 2017, the mortgage delinquency rates tripled in the Houston area as 80 percent of the impacted homes had no flood insurance.
• In the next 30 years, Zillow estimates that 386,000 coastal properties worth almost $210 billion today could be at risk of chronic or permanent flooding.

• Investors are flocking to municipal bonds, including over $8 billion into high-yield, “junk” municipal bonds between January and May 2019.
• Despite assurances from ratings agencies like Moody’s and S&P that they consider climate risks in municipal bond ratings, highly vulnerable cities like Charleston and Boston maintain perfect credit ratings, and no rating has been downgraded to reflect climate risk.
• BlackRock estimates that within 10 years 15% of the S&P National Municipal Bond Index (by market value) will come from regions facing 0.5 to 1 percent annualized climate-inflicted GDP losses.  

• Thirty-five central banks around the world have recognized the emerging risk of climate-triggered financial volatility and have started to monitor and stress test banks for climate-related financial risk.
• There is growing congressional pressure for the U.S. Federal Reserve to join them.
• Federal Reserve Board Chairman Powell has stated that current efforts to monitor weather-related damage are adequate, but the San Francisco Fed published a letter in March 2019exploring the implications of climate change to Federal Reserve activities.

• Indicated by the past months of political uncertainty in Congress over disaster relief, federal programming for disaster relief is increasingly difficult to pass, indicating a potential tipping point for continued federal bailouts after climate disasters.
• Congress is stepping up a pre-disaster home buyout program—every dollar of which could provide $7 in savings—but the National Flood Insurance Program is in need of reform. In its current formulation, it warps property markets and inflicts higher uninsured losses on local communities due to its inconsistent approach to zoning.
• To help communities reduce exposure to climate risk, the Insurance Commissioner of California has appointed an official to leverage insurance industry assets, which could amount to $30 trillion in total assets under management.

• “Investors are not looking for companies to be completely immune from climate risk—that’s not possible—but they need companies to understand it, disclose it, and communicate about how that risk will be managed (just like companies have to do with any other type of risk).”
• “What is unacceptable is to have a view of the future, whether in your business plan, in policy planning or even in outlooks and forecasts for the future that fails to incorporate the idea that climate impacts will pose a new set of challenges from today forward that create a fundamentally new operating environment.”

• Sarah Ladislaw: “The insertion of the Green New Deal into the Democratic primary will force candidates to talk about local, tangible climate impacts. That’s likely to carry over to the general election as well.” (Note: it’s now a top issue in the campaign with 96% of Democratic voters express the belief that it’s very important for candidates to support "taking aggressive action to slow the effects of climate change.")
• Of the 24 Democratic candidates running for president, all support ambitious climate action, and 17 endorsed or co-sponsored the Green New Deal resolution.
• Five candidates (Bennett, Biden, Inslee, O’Rourke, and Warren) have launched their own climate plans, which support funding for local resiliency and adaptation.
• But only two (Biden and O’Rourke), include a focus on managing climate business risks in calling for climate risk disclosures from public companies.
• Biden’s plan additionally calls for a National Intelligence Estimate to assess economic security impacts and states intent to work with the insurance industry.