Crises: A Catalyst for Innovation

One undeniable side effect of economic and political crises is the advancements in innovation that can arise. The early 20th century is a formidable example of technological progress developed post-crisis. A similar trend is observable today.

Indeed, epidemics and environmental disasters drive public and private actors to seek solutions. Innovation converges around different technological forces and know-how where finance plays a major role. Droughts, floods, dry rivers, and flooded highways have particularly attracted investors’ attention.

Estimated losses sometimes reach billions and call for action…

Climate Hazards: Significant Economic Costs

Recent events in 2022 highlighted the severe consequences of droughts during the summer. Notably, the lowering of the Rhine River level rendered it barely navigable, affecting the freight of goods and quadrupling transport costs.

The reduction in river transport significantly impacted the industrial activity in the region. This river is an economic artery, linking Switzerland, Germany, France, and the Netherlands. For instance, in 2021, 300 million tons of goods were transported on the Rhine.

In 2022, the impact of restricted river transport due to drought was estimated at 5 billion euros for the German industry alone¹.

However, the impact and consequences of climate hazards persist in the long term. Even in October 2022, 78 French departments were still affected by water usage restrictions.

Transport companies, farmers, insurers, investors, banks, and constructors are all concerned. Companies face direct and indirect consequences of climate risks: supply chain disruptions, additional operational costs, decreased quality, and increased prices of raw materials, biodiversity loss, and freshwater availability.

The new European climate regulation, called the “CSRD” (Corporate Sustainability Reporting Directive), places physical climate risks like droughts, floods, heatwaves, storms, and wildfires at the heart of reporting².

Starting in 2024, registered and operating companies in Europe will need to integrate the impacts of climate risks into enterprise risk management. This is a revolutionary step towards resilient and reparative finance.

Historically, physical climate risk has been considered by financial and insurance regulators only in the context of Natural Catastrophes (NatCat). Supported by government funds, the NatCat group includes only earthquakes, wildfires, hurricanes, and major floods. All other natural risks, such as sea-level rise, droughts, and heatwaves, are excluded.

The summer 2022 drought is an example of a physical climate risk not covered by insurance. Indeed, drought is not part of the risks insured by NatCat. Communities and businesses must face these situations on their own. Innovation can therefore be an accelerating lever. New insurance contracts should be developed to protect companies against new types of climate risks.

Finally, climatologists estimate that major French rivers could lose up to 40% of their low flow by 2050. However, groundwater recharge from rainfall could decrease by 30%³.

Financial Modeling of Climate Losses

Forecasting future climate crises is a major and critical issue in the sustainable risk management by financial institutions. For the past three years, the Banque de France has been developing an analysis of climate risk models impacting financial stability⁴. This regulatory initiative is propelling innovation within French ClimateTech and DeepTech. Climate data providers are developing tools to facilitate the integration of scientific data into financial decision-making processes.

Climate scenarios are now widely used to assess potential outcomes of credit risk strategies. Here are some examples of questions being studied: “What would happen if flood risk correlated with different assets? What happens if wildfires and droughts multiply? How does this translate into credit risk?”

Adaptation and Resilience

Is there a link between Net Zero transition and climate resilience? Rebuilding roads and properties after a flood or fire, water and soil remediation are not free from emissions! Anticipating climate risks is a necessary step for carbon offsetting and the Net Zero transition.

Adaptation and resilience projects are costly.

To reduce damage costs and avoid irrecoverable losses and broken lives, we need more mitigation engineering. Environmental security is therefore a priority. It is essential to emphasize that the detailed assessment of expected losses is the only effective argument for investing in mitigation.

Cost of Inaction

Insurance price depends on the expected loss. In France, for assets exposed to high physical risk, the annual premium can reach tens of thousands of euros, without public subsidies. Today, in insurance pricing, the limitation can come from the type of risk and geographical location. There are not yet insurance contracts for all climate risks, regardless of the region.

The global availability of affordable and effective insurance for heatwaves, droughts, and other climate risks is the innovation challenge today.

Risk pricing is an essential argument for investors and asset managers.

The additional innovative part is the prospective evaluation of climate risks. The complexity of raw scientific climate data is the main reason why insurance companies do not yet use these data.

Social Justice

The insurance protection gap is greater for poor families and poor countries, where insured losses are less than 10% of total damages. These people cannot afford insurance and have no budget for reconstruction after a climate disaster. Families with children and retirees are the least protected. Unaffordable insurance means no insurance.

Need for Innovation

Annual insurance reports tell us that a quarter of flood losses and damages occur outside official flood zones. Indeed, “official” zones only delineate known risk areas (observed). Even in many developed countries, this “official” risk zone mapping has not been updated in the past 20 to 30 years! For ClimateTech innovation, this is an obvious opportunity.

Good news: today, there are already around 120 global climate models created by major research institutes. These models calculate and evaluate all possible outcomes and probabilities of climate change.

Elena Maksimovich 

Elena holds a PhD in geophysics and climatology and is also an expert reviewer for the Intergovernmental Panel on Climate Change (IPCC). She is passionate about climate modelling and satellite monitoring over land and sea. With its team of climate data scientists, Weather Trade Net bridges the gap between companies that need technical and scientific climate data. The Weather Trade Net team won an award at London Tech Week’s 2022 startup competition.