Patterns of risk today differ materially from those which occurred in the past and climate shocks are introducing unexpected correlation across lines of business previously assumed to be independent.
“The impact of severe weather events on the frequency and severity of insured and non-insured losses necessitates a re-evaluation of traditional pricing and underwriting approaches,” say authors of a new practice resource document from the Canadian Institute of Actuaries (CIA), entitled Climate Risks for Property and Casualty Actuaries.
The report is written for property and casualty (P&C) pricing actuaries, those working in reserving, risk management, capital modelling and enterprise risk management, along with chief actuarial officers and others in the C-suite, in response to climate events which have necessitated the drafting of advice for practitioners. It was also written in response to Guideline B-15 from the Office of the Superintendent of Financial Institutions (OSFI), which sets out OSFI’s expectations for the management of climate-related risks.
“They’re asking financial institutions to consider climate as one of their key risks. They’re also asking companies to disclose certain numbers as well, as part of that B-15 overarching guideline” says Mohan Sivapatham, CIA fellow (FCIA), fellow of the Casualty Actuarial Society (FCAS) and member of the CIA’s Climate Change and Sustainability Practice Committee. “You are going to be required to look at this problem from a multitude of angles. A wide variety of subject matter experts need to come together to come up with a better solution. I think that’s where we need to go,” he adds in an interview with the Insurance Portal.
As for the report’s assertion that the impact of severe weather events on the frequency and severity of insured and non-insured losses necessitates a re-evaluation of traditional pricing and underwriting approaches, Sivapatham notes that this is generally understood, but may not be happening everywhere in the same way or at the same pace.
Quantifying the impact
In looking at ways to quantify the impact climate-related events have on insurers’ balance sheets, Sivapatham notes that there are different pathways or scenarios, some rosier than others, which could be under consideration, depending on the science literature being relied upon at the time.
“We are trying to help the community translate those pathways so they can then model those things,” he says, “so they can come up with a view that they can present to their stakeholders.”
Transitioning to do business with new patterns of risk that differ materially from the past is a reality that actuaries are adapting to with great difficulty and care, he adds.
“Events such as wildfires, dangerous heat, flooding and ecosystem degradation are exhibiting signs of regime change, reflecting a transition to a new, persistent pattern of risk, rather than historical variability,” the report states. “Climate considerations will not affect all lines of business or exposures equally.”
Risk selection and segmentation
The report also looks at rate-level considerations, risk selection and segmentation and considerations for pricing and underwriting.
In reserving, for example, it notes that climate risk is becoming increasingly critical, “making traditional reserving methods less reliable because they rely heavily on the assumption that historical risk patterns will repeat. Emerging climate-related perils fundamentally challenge this assumption,” they write. “Continuing to document the rationale for assumptions and scenario choices, together with transparent disclosure will be critical as reserving practices evolve to incorporate climate risk.”
The document also notes the different concerns which should be taken into consideration over the short, medium and long-term for companies.
Short term, they note the risk of “double hit” scenarios where catastrophe simultaneously drives up liabilities while also depressing asset values. In the medium term, they say insurers may wish to consider alternative risk transfer programs, noting that TD Insurance’s catastrophe bonds have set a clear precedent for Canadian insurers who wish to access capital markets directly to diversify their reinsurance.
Net-zero transition pathways
Over the long term – seven years or more – they also say capital allocation strategies will need to increasingly align with net-zero transition pathways, “as underwriting carbon-intensive industries may attract punitive capital charges or reputational risks,” they write. Similarly with assets, “as capital reallocates toward green assets, a brown discount on carbon-intensive holdings may widen rapidly, leading to stranded assets precisely when liquidity is needed most to cover claims. These developments may warrant a proactive, long-term review of the investment portfolio’s exposure to transition risk.”
They conclude saying climate change is fundamentally redefining the risk landscape for P&C insurers, as reliance on historical loss experience is increasingly inadequate, particularly for secondary perils.
Greater financial resilience
“Correlated balance sheet shocks, in which a major physical catastrophe drives claims liabilities upward while market volatility simultaneously devalues investment assets, can undermine traditional diversification benefits,” they write. “Managing climate risk is an important consideration for long-term solvency and may help organizations move beyond basic regulatory compliance toward greater financial resilience.”
The practice resource document, not designed to be a prescriptive manual, was written by Sivapatham, along with Carl Lussier, Harlem Carrier, and Huston Cheng. “Different actuaries have different skillsets,” Sivapatham says. “It takes a village.”
As for feedback, he says companies definitely care about building systems and understandings of risk that go beyond basic regulatory compliance. “They’re putting investment and capital into things like catastrophe modelling, things like geospatial tracking, and more novel solutions to manage this risk and not solely rely on their traditional expertise methods,” he says. “If you don’t care about it, someone else is caring about it and that someone else is probably going to underwrite, price, reserve and operate better.”
