Natural hazard risk is increasingly shaping capital allocation across financial markets. With insurance capacity tightening and physical risks becoming more financially significant, investors will increasingly face these exposures across a wide range of asset classes.
A new 12-page study paper “Who's holding the risk? How natural catastrophe risk modelling is evolving and distributed across the financial system” by multinational asset management company
Schroders Capital reveals that success will depend less on avoiding risk than on understanding how markets price, transfer and reward it.
An Insights report said, “This places greater emphasis on risk modelling. Our latest paper explores why catastrophe models have become essential investment tools, and how investment outcomes depend as much on the judgment of managers as on the models themselves.
“We increasingly observe large institutional investors adopting a total portfolio perspective when assessing long-term structural trends. With that in mind, we also take a look at a series of examples of asset classes and strategies, based on our own investment toolkit and expertise, that enable investors to respond to increasing natural hazard risk across their portfolio.”
Key takeaways from the report include:
- Natural hazard risk is a systemic macroeconomic issue, not just an insurance issue. As insured losses rise and insurance capacity becomes more constrained, risk is redistributed across households, lenders, capital markets, institutional investors and governments, creating new transmission channels and investment considerations.
- Understanding the risk model – and how it is used – is as important as understanding the asset. Catastrophe models are essential tools for pricing and allocating capital, but like all models they have limitations, and are evolving to catch up with a rapidly changing set of risks. As such, investors need to evaluate how managers interpret model outputs, account for uncertainty and manage tail risks, rather than relying on modelled scores alone.
- Risk transfer creates attractive investment opportunities where capital is priced appropriately. Insurance linked securities, securitisation and other risk-transfer markets can offer attractive returns by absorbing catastrophe risk when pricing reflects expected losses and uncertainty, while at the same time helping to improve the resilience of the wider financial system.
- Adaptation and resilience represent a growing structural investment theme. Beyond transferring risk, investors can access opportunities to invest in infrastructure and real estate strategies that are enabling more resilient real assets, as well as into private equity strategies that are supporting the development or expansion of adaptation technologies and services. These help reduce vulnerability while supporting long-term value creation.
- Competitive advantage will increasingly come from superior risk management. As natural hazard risks evolve, successful investors will combine robust modelling with expert judgement, proprietary analysis and active portfolio management to identify opportunities, manage downside risk and allocate capital more effectively.