Ortec Finance, a leading provider of technology and risk management solutions for financial institutions, has found that transition risks as a result of a disorderly transition to net-zero could affect European insurance company investment returns by up to 13%* in the short term, while longer term physical risks resulting from a lack of action could have far more reaching consequences, resulting in declines of up to 23% by 2050**.
These findings are revealed in Ortec Finance’s inaugural European insurance company climate risk report, in which it analyzed the impact of climate change on a reference portfolio* of European insurance companies, representing their average asset allocation.
Applying seven possible climate scenarios, which include the impact of climate tipping points in its high warming scenarios, Ortec Finance’s research found that transition risks are likely to be the dominant climate risk from 2025 to 2030. The cumulative impact of additional low-carbon policies, revised Nationally Defined Contributions and net zero target reviews by global investor alliance groups could accelerate the stranding of fossil fuel assets, triggering market overreactions and widespread disruption. Under the most extreme outcomes of a disorderly transition, this could result in a 13%* reduction in investment performance in the near future, followed by a moderate pace of recovery thereafter.
“In the event of a disruptive transition, equity investments would be the most impacted, potentially suffering a 25% drop in returns, followed by alternative and real estate investments, while fixed income investments will be more resilient,” said Doruk Onal, Climate Risk Specialist at Ortec Finance.
In the longer term, it is anticipated that rising carbon emissions in the absence of further decarbonization efforts will increase levels of physical risk, leading to severe financial impacts by the mid-2030s. In a worst-case scenario, the average European insurer’s investment return could decline by 5%** within the decade, quadrupling to 21%** within six years thereafter, and deteriorating further to 23% by 2050**.
“Severe physical risks could slash real estate and equity portfolio returns by more than 50%** by 2050, as increasing frequency of extreme weather events affecting agriculture, labor and industrial productivity, have a profound impact on economies and assets,” he added. “In this scenario, both real estate and equities, which together comprise almost 30% of European insurers’ portfolios, could yield less than half of expected returns.”
While short-term cumulative returns for an average European insurer due to low-carbon policies and decarbonization activities could decline by 13%*, this reduction is less than half of the potential decline of up to 23%** in a scenario where active decarbonization does not occur in the near future. Losses are likely unavoidable in all scenarios, but the extent of these losses will depend on the time horizon in which they occur.
For more detail and statistics, please refer to the full report: Climate risk assessment – European insurance companies
*Figure derived from Ortec Finance’s Net Zero Financial Crisis Scenario Stress
**Figure derived from Ortec Finance’s High Warming Scenario Stress
***Reference portfolio represents the average allocation of a European insurance company. This allocation is derived from the EIOPA (European Insurance and Occupational Pensions Authority) Reference Portfolios, with data released in March 2023.
Contact
Doruk Onal
Climate Risk Consultant