What is Climate Change?
According to the Met Office, climate change refers to a large-scale, long-term shift in the planet’s weather patterns and average temperatures.
Why should actuaries and insurers care?
To answer this question, we must understand the impact of climate change on the insurance industry.
The changing weather patterns and a changing climate will affect property- and agriculture-related losses through changes in frequency and severity of flood, wind, drought, hail and other climate-related events. Insurance companies will need to take into consideration of the changes in climate risks when coming up with pricing, reserving and capital modelling.
Besides that, a changing climate may alter the distribution or prevalence of both infectious and non-infectious diseases like malaria and asthma in insured populations. Thus, a changing climate could increase the number of deaths linked to extreme temperatures. It is worth noting that the relationship between disease and climate change is complex – for some populations, mortality and morbidity may fall.
Climate change could lead to rapid changes in the population of different geographic areas. For example, mass migration occurs due to water shortages or floods. Populations that have either shrunk or increased dramatically because of migration could have very different risk profiles than before in terms of different demographic profile, socio-economic status, education, and so on.
Due to changes in mortality/morbidity and population and other climate risks, actuaries should be mindful of the huge uncertainty surrounding climate change. There is a risk that the different models used by actuaries do not adequately represent the reality of a world impacted by climate change when calculating premiums, reserves and capital. In particular, actuaries should consider how sensitive their models are to assumptions and data that could be impacted by climate change.
If the insurer finds that there is greater uncertainty, they will typically charge higher prices for the risks undertaken. Therefore, insurance with greater climate risks may become less affordable. For some types of insurance, the uncertainty around climate risks could lead to prices that few customers or businesses could afford and lower rates of insurance penetration. It could also widen the protection gap i.e. between those who can afford protection and those who cannot.
Table 1: Impact of climate change on the insurance industry
Source: Charpentier, A. (2008)
Table 1 shows the impact of climate change on some risks, inspired by Mills et al. (2005), where ‘‘ + ’’ stands for ‘‘positive’’ financial impact (a gain) and “ – ” stands for “negative” financial impact (a loss).
Therefore, it is important to take note that climate change does not only have negative impacts for insurers.
Conclusion
Actuaries and insurers should be aware of the adverse impacts of climate change on not just their business, but also the environment and people. The future is not set in stone, so all parties involved in the insurance industry should come up with innovative products to tackle the issue heads-on.
This post was originally written for the Heriot-Watt University Students’ Actuarial Society November 2019 Edition.
