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Physical Climate Risk Factors and an Application to Measuring Insurers’ Climate Risk Exposure

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Abstract
We construct a novel physical risk factor by forming a portfolio of REITs, long on those with properties more exposed to climate risk and short on those less exposed. Combined with a transition risk factor, we assess the climate risk exposure of P&C and life insurance companies in the U.S. Insurers can be exposed to climate-related physical risk through their operations and transition risk through their $12 trillion of financial asset holdings. We estimate insurers’ dynamic physical and transition climate beta, i.e. their stock return sensitivity to the physical and transition risk factors. Validating our approach, we find that insurers with larger exposures to risky states have a higher sensitivity to physical risk, while insurers holding more brown assets have a higher sensitivity to transition risk. Using the estimated betas, we calculate the expected capital shortfall of insurers under various climate stress scenarios.

Suggested Citation

  • Robert Engle & Shan Ge & Hyeyoon Jung & Xuran Zeng, 2023. "Physical Climate Risk Factors and an Application to Measuring Insurers’ Climate Risk Exposure," Staff Reports 1066, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednsr:96484
    Note: Revised November 2024. Previous title: “Measuring the Climate Risk Exposure of Insurers.”
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    References listed on IDEAS

    as
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    2. Massa, Massimo & Zhang, Lei, 2021. "The Spillover Effects of Hurricane Katrina on Corporate Bonds and the Choice Between Bank and Bond Financing," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 56(3), pages 885-913, May.
    3. Shan Ge, 2022. "How Do Financial Constraints Affect Product Pricing? Evidence from Weather and Life Insurance Premiums," Journal of Finance, American Finance Association, vol. 77(1), pages 449-503, February.
    4. Painter, Marcus, 2020. "An inconvenient cost: The effects of climate change on municipal bonds," Journal of Financial Economics, Elsevier, vol. 135(2), pages 468-482.
    5. Stefano Giglio & Matteo Maggiori & Krishna Rao & Johannes Stroebel & Andreas Weber & Stijn Van Nieuwerburgh, 2021. "Climate Change and Long-Run Discount Rates: Evidence from Real Estate [Abrupt climate change]," The Review of Financial Studies, Society for Financial Studies, vol. 34(8), pages 3527-3571.
    6. Frederick Schuh & Tanja Jaeckle, 2023. "Impact of hurricanes on US insurance stocks," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 26(1), pages 5-34, March.
    7. Engle, Robert, 2002. "Dynamic Conditional Correlation: A Simple Class of Multivariate Generalized Autoregressive Conditional Heteroskedasticity Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(3), pages 339-350, July.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    insurance; climate change; physical risk; transition risk;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G2 - Financial Economics - - Financial Institutions and Services
    • G3 - Financial Economics - - Corporate Finance and Governance

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