5.2.1 Physical risks

Physical risks arise from climate-related damage such as storm surges, hail, droughts, heavy rains, flooding and extreme heat. As the Earth is getting warmer and the climate is changing, the Royal Netherlands Meteorological Institute (KNMI) expects an increase of extreme weather conditions in the Netherlands.1 One of the key messages from the 2018 IPCC report is that we are already seeing the consequences of 1°C of global warming through more extreme weather, rising sea levels and diminishing Arctic sea ice.2 So, global warming will lead to an increase of physical risks.

These risks will be primarily felt by non-life insurers, as climate-related claim burdens are likely to increase.3 DNB concludes that this will put an upward pressure on insurance premiums, which could lead to shock induced price increases. However, climate change is making it increasingly difficult to estimate the likelihood of extreme weather. Insurers rely to a significant extent on catastrophe models that do not explicitly address climate change trends that are relevant to the Netherlands. This could lead to a potential underestimation of risks. Being unable to properly estimate the risk of natural disasters occurring can have major consequences for insurers. This was for example shown in 2016, when several Dutch insurers suffered losses after being surprised by a major hailstorm in the south of the country. The resulting damage considerably exceeded the estimates generated in their disaster models.4

Not all climate-related losses are insured. When there is no insurance coverage, these losses have to be borne by households, businesses and/or governments. This can have consequences for financial institutions’ exposure to these parties, through mortgages, corporate loans, shares or bonds. One of the risks the low-lying Netherlands are especially vulnerable to, are flood risks. Scenario analysis carried out by DNB shows that the occurrence of floods could lead to losses ranging between €20-60 billion, with at least several billions being absorbed by the balance sheets of financial institutions.5

In addition, the financial sector could face all sorts of secondary effects such as lower economic growth, political instability due to rising migration, and increased mortality as a result of heatwaves.6 It is difficult to determine exactly how these developments will affect Dutch financial institutions’ assets. However, if no or insufficient action is taken to reduce global warming and the consequences of climate change will be acknowledged only after it is too late, this might result in sudden revaluation of financial assets and severe financial shock.7