Impact of Climate Change on Risk Profile

[Dar_Shan0209]

Hi Anna and David
I hope you are well? I was impressed by the new material on climate change that was added in the SP9 CMP Upgrade for 2022. Page 22a has a question: " Describe in detail the potential impact of these three categories on the risk profile of a life insurance company." I was wondering how the solution might change if the question would have been for a general insurance company and a benefit scheme as well. Could you please let me know if the below is fine:

• Physical Risk

[GI]: The frequency and severity of claims for a general insurance company would increase. For example, harsher weather makes driving conditions more severe which could cause an increase in accidents. Extreme CAT events, for example, hurricanes or cyclones would cause further damage. Increased likelihood of pandemic could make an increase in claims experience for business interruption classes of business. An increase in CAT events would lead to a demand surge hence increasing the cost of claims. These transition effects could manifest as a ‘shock’ impact (eg from an adverse weather event) or a ‘trend’ impact’ (eg from gradually rising temperatures). Physical risks may also impact adversely on the insurer’s asset values eg increased instances of extreme weather could result in economic losses to many companies. Operational risks may increase, for example, due to property damage and business interruption to the short-term insurer itself, eg if based in a geographical area that is susceptible to climate change and suppliers or outsourcers used by the insurer vulnerable to business interruption. Regulatory capital requirements may increase as the adverse weather events (in respect of which the insurer seeks resilience) become more extreme.

[Benefit scheme]: The same example as for the life insurance company would apply for the benefit scheme here?

• Transition Risk

[GI]: The same example as for the life insurance company would apply for the general insurer here?

[Benefit Scheme]: The same example as for the life insurance company would apply for the benefit scheme here?

• Liability Risk

For this risk, I am a bit lost on the example presented for the life insurer. Could you please how would there be an increase in credit default risk and market risk in respect of investments in companies who are adversely affected by liability risk? Perhaps this may help in finding examples for a short-term insurer and a benefit scheme.

Many thanks for your time and help. PS: I am assuming here that the examiners do not assess climate change from florist, wind power company etc... Is the past a good guide for the future though...

 

[Anna Bishop]

Hi Darshan

Your points look great to me. I've had a look in SP7/SP8 for you and here are my findings, which could make some useful additions to your answer.

Physical risk
- increased severity and frequency of extreme weather & associated events (eg heatwaves, precipitation, flooding, hurricanes, windstorms, droughts, earthquakes, subsidence, wildfires)
- increased claims cost and frequency as a result on many lines (eg liability, property damage, business continuity)
- adverse effects on the 'insurability' of certain risks, regions, lines, ie on the availability of insurance, eg certain coastal areas, buildings that have not been built with due regard to climate risks
- more obligation on governments to provide insurance, eg FloodRe in the UK
- adverse impact on the availability and cost of reinsurance, more caps on cover
- insurers may respond by increasing premiums, reducing cover, excluding certain perils, strengthening u/w and claims control, withdrawing products, changing geographical market, increased demand reinsurance
- historical patterns used for modelling less likely to be relevant in the future, generally increased uncertainty in claims
- possible mass migration & changes in economic activity, which will impact on the investments of the company, staffing, location of buildings

Transition risks
- change in the nature of commercial risks, due to more sustainable manufacturing processes
- change in the nature of motor risks, due to green vehicle technologies
- change in the nature of product liability risks, eg from energy storage batteries
- pressure not to offer insurance to fossil fuel companies

Liability risks
- liability risks due to increasing lawsuits relating to climate change
- these may have an adverse impact on the financial health of some of the (commercial) policyholders of the general insurer, eg if the insurer insures fossil fuel companies
- in turn this may make them more likely to go bust & default on premiums (increased credit risk to the general insurer)
- it may also adversely affect the investment return of the companies in which the insurer is invested (market risk)
- there may also be a direct impact on the general insurer in terms of increased claims on its liability policies or on directors & officers cover

Generally, increased dependency between risks.

I can imagine the examiners testing climate change risk from the perspective of any organisation!

April 2021 Q2 useful to look at again as along similar lines - general insurer facing climate related risks. Also CP1 April 2020 Paper 2 Q1, which is a composite insurer facing climate change risk.

Hope this helps in some way Darshan
Anna

 

[Dar_Shan0209]

Hi Anna
Many thanks for the above. This is definitely very helpful. I will also check the 2 questions you mentioned as well.

 

[vidhya36]

Noting few more points as I do the same question -

Physical risks
- increase in crop insurance related claims
- adverse effect on diversification due to different catastrophes occurring in different geographies at same time eg wildfires
- potential reinsurer defaults -> would impact availability and affordability of insurance in the market

Transition risks
- people may become health sensitive eg they might choose to adopt healthy habits like walking
- climate adaptation might result in positive shifts eg cars replaced by EVs, increase in car pooling
- reputation risk for insurers if more people become climate change aware and purchase insurance from companies with better ESG scores
- regulator might request insurers to mandatorily invest in sustainable investments
- potential insurance market for new products eg solar panels

 

[Anna Bishop]

Thanks Vidhya - good luck to all in the forthcoming exam.