The rising threat of extreme weather, compound events and loss aggregation call for a fresh approach to modelling and assessing the impact of climate change over multiple time horizons.
The latest report from the Intergovernmental Panel on Climate Change (IPCC) on the physical science behind climate change sends a stark message to the world, and insurers.
Released on 9 August, IPCC Working Group I’s Sixth Assessment Report (AR6) found that every region faces an increasing impact from climate change, many of the observed changes are unprecedented, some may be irreversible, and human influence is unequivocal.
The fundamental conclusions have not changed much since AR5 in 2013. However, this time the language is much stronger, and the evidence more definitive.
Until recently, it had been difficult to attribute any one extreme event to climate change rather than natural variability. However, advances in attribution science and modelling now prove climate change is impacting the frequency and severity of some events.
For insurers, climate change is no longer a future threat. Its impact is being felt today and continues to evolve. Going forward, perils directly driven by temperature, such as heatwaves, wildfires, droughts, heavy rain and floods, will cause more losses – although the magnitude varies by region and future emissions scenario.
A key issue for insurers that was highlighted in the report is the increased likelihood of compound events – multiple perils that occur simultaneously, such as the tornado, hail, rain and flash flooding events that wreaked havoc in Europe in July this year.
This raises serious concerns over the aggregation of losses as well as the adequacy of insurers’ cat models, which not only treat many perils independently of one another but are also still based largely on historical data. Today’s climate is different to that of a few decades ago and continues to change, so are the industry’s models fit for purpose?
Modelling capabilities are certainly improving. However, the maturity and sophistication of carriers’ approach to understanding climate change varies significantly – with some investing in their own research and accessing world-leading proprietary probabilistic models to other insurers that continue to assess risks year-by-year and make little attempt to quantify the impact of climate change.
AR6 suggests insurers cannot afford to take this approach, as the impact of climate change on loss performance – and financial results – will continue to evolve and escalate over time.
Whether business planning, purchasing reinsurance and completing regulatory disclosures, insurers need to understand the impact and materiality of climate change over multiple time horizons. Sea level rise may not yet influence business written in most geographies today, for example, but could be a common concern in 2050.
Insurers are under growing pressure to address climate change from regulators, which increasingly want to know what exposures may look like in 10, 20 or 30 years, as well as investors, who increasingly demand ESG factors be integrated into business models.
With the need to address climate change seemingly unavoidable, carriers have a growing number of tools at their disposal. Working with partners with deep expertise and sophisticated capabilities of their own is a good way to start.
Guy Carpenter, for example, provides expert advice in addition to a suite of tools including fully climate change conditioned probabilistic models, accumulation layers for perils such as wildfire and the ability to make climate change adjustments to existing cat models.
Engaging with an adviser with a wide view of the market can also help carriers benchmark their approach against competitors, and provides valuable insights into best practices.
As an industry, this is just the start of the journey. We haven’t solved everything yet. Compound events, for example, continue to pose challenges to modelling as well as an ongoing threat of loss aggregation which needs to be addressed.
However, most companies now realise getting to grips with the evolving impact of climate change is increasingly mission critical. AR6 illustrates the need to be proactive now to prosper in the future.