How the analytical tools and methods used in the (re)insurance industry can support Ministries of Finance in their understanding of physical climate risks and their efforts to support climate adaptation

• Holistic risk management includes risk assessment, risk mitigation, and risk financing. A range of models and approaches have emerged to evaluate the potential impact of disasters on populations, infrastructure, and economies, to help quantify the expected losses and probabilities of exceeding certain loss thresholds, and to support decisions about adaptation (or “risk mitigation”) and risk finance.
• Catastrophe (CAT) models:
  – These estimate potential losses from natural or human-made catastrophic events. A portfolio of risks (a selection of assets or asset classes) is modeled against hazard, vulnerability, and exposure to establish “financial loss” based on the simulation of plausible scenarios.
  – Results can inform policies and planning for infrastructure development and emergency response, public insurance schemes, and financial reserves required to cover potential losses, all supporting economic stability in the aftermath of shocks.
  – Climate change can be reflected in the hazard module of CAT models. Incorporating adaptation and resilience measures is challenging, but is an emerging area.
• Risk layering:
  – This involves dividing risks into layers based on the probability and severity of potential losses, each covered by specific financial instruments or strategies.
  – The concept is helpful for exploring the optimal combination of risk retention, transfer, and reduction strategies.
• Insurance protection gap:
  – This represents the portion of economic losses from various risks not covered by insurance or other risk finance instruments.
  – An understanding of the protection gap helps identify the extent to which different agents are underinsured or uninsured, and the potential financial burden on government in the absence of insurance, over time. A proactive approach to addressing this gap can help enhance economic resilience, promote financial stability, support sustainable economic development, and lead to more efficient use of public resources.
• Understanding current and future availability and affordability of insurance against specific climate risks involves analyzing insurance market data covering the supply and demand side, particularly in wildfire-prone regions.

A holistic view of risk involves considering or combining various risk assessment, resilience and adaptation, and financing strategies. Catastrophe models, risk layering techniques, and insurance analysis can be combined to explore what an optimal climate risk financing and adaptation strategy can look like today and for different projected climate pathways at the state, local government, and community levels.