How Climate Change Impacts Reserving Practices for the Insurance Industry

Sep 28

I am proud to have been involved over the last year in the Climate Change Working Group that was established in 2022 by the Institute and Faculty of Actuaries (IFoA) to address the needs of the general insurance actuarial community involved in reserving.

The working group has been developing a paper "Reserving for Climate Change" that will be published later this month, that seeks only to start the discussion around how reserving actuaries can respond and adapt to climate change in their professional capacity.

Up to this point, there was a relatively common perception that climate change was not really a reserving issue with focus being placed on pricing for the evolving risk. Assumptions were made that up until a major (climate-induced) natural catastrophe had arisen, this was an area for pricing and catastrophe modelling, and once it had happened, the tools were well-established and reserving actuaries knew what they were doing.

Background to the paper

For reserving actuaries, climate change is an emerging issue that occurs across portfolios and in unexpected places. Not only does climate change need to be a feature of natural catastrophe and unearned exposure reserving, its impact on any property and casualty portfolio needs careful consideration. Prior earned business is at risk of climate change impacts as well, reaching back from today into the back-book. Climate change related physical, transitional and litigation risks are all of relevance for reserving actuaries.

Indeed, the challenge of doing so may well be particularly acute, as many claims arising in connection with climate change lack a clear identifier of this as an underlying cause.

This paper explores how reserving actuaries can avoid giving false comfort without raising undue alarm.

The working group main objectives

The working group was split into three sub groups covering ongoing litigation; communication through suggested wordings and the development of "heat maps" across insurance portfolios.

I have been leading the "heat maps" sub group and which has tried to answer the question of where reserving actuaries should begin when trying to analyse the exposure to climate change within the portfolio. To begin the process of addressing this vast topic, we have set out a range of questions that reserving actuaries can use to begin the process of information gathering. We then present heat-maps for two lines of business, Property Damage/ Business Interruption and Directors & Officers.

The main objectives have been considered the most significant risks for insurers specifically Directors and Officers (D&O) and Property Damage and Business Interruption (PDBI) and to also rovide a framework that reserving actuaries can adopt in considering their portfolios more widely.

Directors & Officers - Heatmap

Whether a D&O insurance loss is triggered by any of the current or future climate litigation cases will depend on the specific language of a company’s insurance policy. This can vary significantly across different insurers and includes whether the costs incurred in defending a cases is covered.

Some of the climate change related triggers include failure to comply with regulatory requirements. In these cases, the increase in climate change regulatory reporting requirements could increase the frequency of claims. Other types of claims such as ‘Greenwashing’ or climate attribution for past emitters are examples of possible new types of D&O claims.

The D&O heatmap includes a RAG status has been applied to highlight areas of most concern to re/insurers and cases can generally be classified between:

Inaction
Errors in Action and
Misstatement

Property Damage and Business Interruption - Heatmap

The heatmap for Property Damage and Business Interruption splits the perils into physical and transition risks. Acute physical risks are likely to increase property damage claims and can lead to supply chain disruptions that include increases in non-physical damage claims that may be insured through newer types of insurance including parametric and index based policies .

Some of the main property related perils impacted will continue to be flood, windstorm and wildfires. Chronic physical risks are associated with changing climate patterns such as temperature changes/volatility and rising sea levels that lead to a range of impacts such as changes in land and soil productivity. The main concerns for insurers relate to drought and extreme heat increasing subsidence claims as well as extreme cold conditions such as freeze.

Transition related risks will include greater uncertainty in future claims relating to for example insuring a new range of assets including renewables such as wind and solar farms as well as electric and hydrogen vehicles emanating from changing government policies and technology and societal shifts in demand patterns.

Actuaries should therefore consider whether the reserves already include an implicit allowance for climate change across the various insurance classes.

Next Steps and Recommendations - Use of Underwriting Portfolio Climate Risk Assessment Tools

The Working Party recommends that actuaries also consider the uncertainty around the data and that the full science of how to allow for climate related risks in reserving has not yet been fully developed. It is also important to recognise that some market participants may withdraw from the market due to the risks associated being too high or expand into these due to the opportunity which may disguise other changes.

Actuaries along with other stakeholders such as risk managers and underwriters within their organisations should seek to ideally develop tools such as a web-based survey questionnaires that can be designed to gather information about how businesses are thinking about the impacts on climate change and can be used to determine benchmarks to ensure a robust ongoing process to identify climate change risks and opportunities.

More details can be found in a report by ClimateWise (part of Cambridge Institute for Sustainability Leadership (CISL)) entitled "Insurers in Paris-aligned climate transition: Practical action towards net zero underwriting" that I contributed to through the design of an underwriting portfolio climate risk assessment tool that was used in one of the three main case studies in the following report. https://www.cisl.cam.ac.uk/resources/publications/insurers-paris-aligned-climate-transition.

The main reasons for undertaking such an exercise across the business are to:

Ensure a robust ongoing process to identify climate change risks and opportunities.
Help identify, assess and rank the impacts of climate change and emerging trends across each line of business.
Engage with key stakeholders (i.e., underwriters).

The main outcome and benefits of such an exercise are to:

Assess the impact of climate change across each line of business for both claims and premiums.
Capture detailed climate insights and trends from the first line risk owners and other key stakeholders.
Support future business decisions and operational processes in areas such as risk appetite, pricing, reserving risk aggregation/ exposure management, new product development and improved internal reporting.

The exercise above may also have a second order impact on the business actuaries are working in. For example the heatmap analysis could give additional insights to shape the risks insured going forward. The analysis could help revise the premium pricing methodology by underwriting teams as the risks underwritten may be affected by climate related risks.

I look forward to sharing the full report once it has been published and I welcome your thoughts and feedback.

Please contact me if you want to learn more about the IFoA Climate Change Working Group and its findings.

Direct Message: LinkedIn

Email: martin.massey@oneriskconsulting.com

Book: Climate Change Enterprise Risk Management: A Practical Guide to Reaching Net Zero Goals

Cherish Harding