Hyeyoon Jung, Robert Engle, Shan Ge, and Xuran Zeng

As the frequency and severity of natural disasters increase with climate change, insurance—the main tool for households and businesses to hedge natural disaster risks—becomes increasingly important. Can the insurance sector withstand the stress of climate change? To answer this question, it is necessary to first understand insurers’ exposure to physical climate risk, that is, risks coming from physical manifestations of climate change, such as natural disasters. In this post, based on our recent staff report, we construct a novel factor to measure the aggregate physical climate risk in the financial market and discuss its applications, including the assessment of insurers’ exposure to climate risk and the expected capital shortfall of insurers under climate stress scenarios.