CEOs looking to climate proof their businesses need to look beyond physical infrastructure. The financial systems that bind firms and consumers together through sales contracts, futures markets, insurance pools, and other mechanisms are also facing the effects of climate change. When these systems work well, they distribute risk and dampen volatility. However, under pressure, they can reach a tipping point—potentially leading to shocks, contagion, and disruptive transitions.

Many current models suggest that financial systems respond to stress in a linear fashion: for example, as temperatures rise, prices rise. But the relationship may break as these pressures intensify, leading to nonlinear and highly disruptive changes that fundamentally transform operating environments, resulting in repriced assets, redistributed risks, and altered incentives.

When Hurricane Katrina hit Louisiana in 2005, as well as the cost in lives and damage, the financial mechanisms supporting sectors like real estate passed a tipping point. For example, the surge in insurance losses forced insurers out of business and out of the market, leaving households without coverage.

Leaders who prepare for such risks by following a strategy of “anticipate, innovate, and collaborate” will be better placed to shape the future—and to create new value. Solutions include using advanced analytics tools to better manage risks, introducing new products and services that reflect the increased volatility, and working across industries and through public-private partnerships to share risk.