Three Ways Financial Institutions support the German Property Market against Physical Climate Risks

• German financial institutions are increasingly conducting comprehensive physical climate risk assessments and stress tests to identify vulnerable properties and implement risk-mitigation strategies.
• Acknowledging the systemic impact of climate risks, these institutions are incorporating climate factors into their investment policies and decision-making processes regarding the real estate sector.
• German financial institutions are participating in cooperative data-sharing initiatives to improve climate risk management across the industry.

The German property market is confronting a growing array of climate risks, from extreme weather events to shifting precipitation patterns. These hazards pose significant challenges to property investors and stakeholders, reshaping the landscape of real estate investment.

In response, financial institutions (FIs) such as Deutsche Bank, CommerzBank and Allianz are stepping up to fortify the market against these challenges and adopt innovative strategies to bolster resilience.

In this article, we examine three ways in which financial institutions are supporting the German property market against physical climate risks, drawing from relevant insights to explore their recent approaches in mitigation efforts.

Climate change poses multifaceted risks to the German property market and channel across the financial industry, with implications for property values, insurance costs, and asset resilience – often resulting in assets stranding, loan default and limited ability to transfer risks.

According to Clean Energy Wire, a recent report commissioned by the German Association of Building Materials Trade shows that German towns and cities are not sufficiently ready to deal with physical climate change risks, and therefore necessitate proactive measures to enhance resilience.

For instance, DWD, a German weather service, reported a 100-liters rainfall in less than 24 hours in the Saarland (in May 2024), “for which rivers and infrastructures were not prepared” and resulting in a severe case of flash flooding across the state - which is also a worse case, compared to 74 liters of rainfall experienced during the entire month of April in 2023.

The increasing severity of such event mostly affects insurance costs and property values among other things. German private insurers, particularly, have a history of providing flood coverages for properties in low-risk areas essentially - avoiding high-risk zones near rivers.

In the case of Saarland, this could mean that more frequent and severe flood events are likely to simultaneously increase the exposure of properties in the area, and discourage insurers from offering coverage due to the heightened risk.

This could lead to a decrease in property values as potential buyers may be deterred by the lack of available insurance and the increased risk of flood damage. Consequently, property owners may face higher costs for flood protection measures and potential losses in property value.

For example, data from Statista show that the estimated average cost of premium insurance in Germany between 2019 (€213) and 2024 (€264) has increased by approximately 23.94%.

Among several reasons ranging from worsening inflation and economic conditions to higher medical costs, increasing climate physical risks appear not as a main factor but rather as a catalyst to other existing factors.

In fact, the German Insurance Association’s CEO Jörg Asmussen - noting a slight increase in insurance premiums in 2023, and calling for more vigilance in 2024 - claimed that floods occurring in Northern and Central Germany around Christmas time caused an estimate of €200 million in losses.

He further revealed that “the states and municipalities have major deficiencies when it comes to prevention and adapting to climate change. Many of our problems, especially when it comes to flood prevention, are homemade and entirely preventable”.

This underscores the importance of proactive measures, such as improved infrastructure and planning, to mitigate the impact of these increasingly severe weather events. It also highlights the need for a re-evaluation of insurance strategies to ensure that they are aligned with the changing climate risk landscape.

Financial institutions play a critical role in mitigating climate risks in the German property market through various initiatives.

One key approach involves integrating climate considerations into investment decisions and risk management practices. By conducting thorough climate risk assessments and stress tests, financial institutions can identify vulnerable assets and develop strategies to enhance their resilience.

Additionally, financial institutions are collaborating with industry stakeholders to share data and best practices, fostering a collective approach to climate risk mitigation.

For instance, in a 2023 sustainability report, Allianz, one of Germany's largest insurance services providers, announced a comprehensive strategy to integrate climate considerations into their investment and risk management practices.

This initiative includes thorough climate risk assessments like stress test and scenario analysis to identify vulnerable assets and develop resilience strategies. As Allianz’s “materiality analysis under CSRD found climate-related opportunities to be material for the property-casualty insurance and proprietary investments”,  integrating these exercises involves the use of both qualitative and quantitative assessment models for physical risk analysis to examine drivers of losses such as climate litigation, extreme weather events (acute physical risk), and climate-related volatility (chronic physical risk).

The scenarios provided by the NGFS are utilized to derive financial market variables. These variables are then applied in the market stress component. Allianz further indicates that the scenario variables employed in the property-casualty and life/health underwriting stress modules are obtained from hazard models.

These models are dependent on the Representative Concentration Pathways (RCPs) 2.6, 4.5, 6.0, and 8.5. That being said, financial institutions like Allianz are crucial in mitigating climate risks in the German property market by incorporating climate considerations into investment decisions, conducting thorough risk assessments and stress tests, and collaborating with industry stakeholders to enhance resilience against climate-related vulnerabilities.

Financial institutions in Germany are taking proactive measures to assess and mitigate climate-related risks in their property portfolios. Through advanced climate risk stress testing methodologies, banks and investment firms evaluate the potential impacts of various climate scenarios on their assets.

These stress tests incorporate factors such as increased flood risks, heatwaves, and storms, allowing institutions to identify vulnerable properties and implement risk-mitigation strategies.

By conducting comprehensive physical climate risk assessments, financial institutions can make informed decisions, safeguarding their investments and the broader property market against climate-induced disruptions.

However, many institutions are still grappling with climate risk data collection, particularly forward-looking physical risk data. For example, a 2023 research report by Deutsche Bank highlights that while results of climate risk stress tests “are preliminary and subject to limitations”, data gaps (data quality and accuracy) and modelling constraints are the most notable challenges.

The Bank further notes that, “with respect to physical risk, there is a lack of precise geocoded data and banks often do not have information on different business locations of large counterparties”.

This could also explain why institutions such as the Deutsche Bank prioritised the development of a framework for transition-focused climate stress testing in 2023, and Federal offices like the Federal Ministry for the Environment, Nature Conservation and Nuclear Safety face challenges to delivering its 2021 commitment to evaluating the physical risks posed by climate change on its loan portfolios, including those that involve real estate assets.

Such assessment is likely to incapsulate analyses of the potential impacts of climate-related events such as floods, storms, and heatwaves on property values and loan performance.

Recognising the systemic nature of climate risks, financial institutions are integrating climate considerations into their investment policies and decision-making processes.

In Germany, banks and asset managers are increasingly aligning their investment strategies with sustainability goals and climate resilience objectives.

This entails incorporating environmental, social, and governance (ESG) criteria into property investment criteria, ensuring that investments contribute to long-term resilience and mitigate climate-related risks.

By embedding climate considerations into their investment policies, financial institutions not only enhance the resilience of their portfolios but also drive positive environmental outcomes in the real estate sector.

In 2022 for example, Commerzbank has revised its investment policies to prioritize climate resilience in its real estate investments.

The bank intends to evaluate properties based on their sustainability credentials and resilience to climate risks, encouraging the development of climate-resilient buildings and communities.

This is evident in the case of the Deutsche Bank and European Investment Bank (EIB), which jointly launched a reduced-rate mortgage scheme to fund eco-friendly residences. The new agreement is set to offer over €600 million in low-interest mortgages to Germans for the construction of eco-friendly homes and energy efficiency upgrades in existing houses.

Collaboration is key to effectively addressing climate risks in the property market.

Financial institutions in Germany are engaging in collaborative data-sharing initiatives to enhance climate risk management across the industry.

By sharing data on climate hazards, property exposure, and vulnerability assessments, banks and insurers can collectively strengthen their understanding of climate risks and develop coordinated strategies for risk mitigation.

However, it is crucial that such collaborations include the expertise of relevant climate data providers, such as Climate X, which offers a range of products in physical climate risk data analytics, crucial to enhance the accuracy and comprehensiveness of climate risk assessments, thereby enabling more effective climate risk management strategies.