This is part four in a series of blogs about nature-related risk from the IFoA’s Biodiversity Working Party. In this post, we focus on nature-related physical risks by providing some examples of their different types.
Nature-related financial risks are gaining prominence, for example through the work of the Taskforce for Nature-related Financial Disclosures (TNFD). Actuaries can play a major role in this field in the future. But before we can discuss modelling the financial impacts and advise our clients, we need a shared understanding of what ‘nature-related physical risks’ mean. This blog shares some real-world examples to bring this concept to life.
Nature-related risks are driven by the global crisis in biodiversity (our outputs explore this in more detail, available on the working party's webpage. They include:
Systemic risks and litigation risks are other categories sometimes used, but this post concentrates on physical risks.
Readers may be more familiar with physical climate-related risks, for example ‘disaster’ events such as floods, hurricanes and wildfires. These risks are known as ‘acute’: they are event-driven and occur at a defined time and place. Nature-related risks can also be ‘acute’, as in the mangrove example below.
The other, and perhaps more significant, category of nature-related risks are ‘chronic’. These are caused by the gradual decline in the services provided by nature as in the pollination example below. These risks are slow-burning but can lead to more dramatic effects in the future if a tipping point is reached. The result is in an irreversible collapse in services provided by an ecosystem.
Animal pollination is critical for the continued functioning of a range of ecosystems. But wild pollinator populations are declining. This is considered a physical risk for a few reasons:
It is estimated that 5% to 8% of global food crop production, with an annual market value of 235 to 577 billion US dollars (in 2015), is directly attributable to animal pollination. This is according to a 2016 report on pollination and food production.
Cacao, for example, is 95% dependent on animal pollination while tomatoes are just 5% dependent, according to a 2020 study by De Nederlandsche Bank (DNB).
And the more pollinator-dependent crops (like cacao and coffee) tend to be leading export products for developing countries. They provide employment and income for millions of people.
Pollinators also support medicines, biofuels such as canola and palm oil, fibres including cotton and linen, and construction materials like timber.
The DNB study quantifies this risk, finding that the Dutch financial sector has exposure of around 28 billion euros to products that depend on pollination.
Mangroves are salt-tolerant trees and shrubs that grow in coastal waters. Mangrove forests provide food and breeding grounds for multiple species and are efficient at carbon sequestration. But the world lost 20% to 35% of its mangrove area between 1980 and the early 2000s, found a 2010 research paper on mangrove extinction risk. This loss continues, although the rate has slowed in recent years.
This is considered a physical risk because mangroves protect coastal communities from hurricanes and tropical storms. They block storm surges and dampen waves.
Mangroves help to protect the property and livelihoods of 15 million people living on shorelines. In fact, they help prevent over 65 billion dollars in property damages each year, particularly in the US, China and Taiwan, according to a Global Center on Adaptation piece on mangroves.
It is estimated that the economic impact of Hurricane Katrina (about 150 billion dollars) would have been much lower had coastal wetlands been preserved.
These examples cover just two services provided by nature. If we account for the huge range of other services, the size of the risk quickly mounts up. The DNB study estimates that Dutch financial institutions have lent 510 billion euros to companies that are either highly or very highly dependent on at least one ecosystem service. These statistics shine a light on the financial value of nature, and the risks associated with its decline.
Do you agree with our definitions? Do you know any other examples of nature-related physical risks? How should this impact actuaries’ work?
We’d love to hear your views in the comments on the IFoA's Sustainability Finance Community LinkedIn page.
To find out more about the work of the Biodiversity Working Party visit their website page.
