Climate change: An emerging insurance risk

Climate change is an established area of scientific research and a topic of political debate. And its impacts and importance are now becoming widely recognised in an economic context. As a result, an increasing number of regulatory, advisory and governmental bodies are engaging with and exploring the topic. This involvement is catalysing the reaction of the insurance industry towards the financial risks of climate change.

The fundamental effects of climate change describe the changing attributes of the global environment, including mean temperatures and annual rainfall. The risks of climate change can be viewed through two key risk channels, ‘physical’ risk and ‘transition’ risk.

The ‘physical’ risk channel describes the risks that emerge as the global environment changes and as demographic experience develops in response to these changing conditions. This may present itself through changes in longevity and morbidity trends, but the physical impacts of geography have the potential to affect the strategy of insurers across target markets and the location of internal operations.

The ‘transition’ risk channel describes the risks emerging as society and world governments move towards a lower-carbon economy. These risks can manifest more quickly than physical risks, and include the effects of emerging regulation, asset repricing and changing laws and policies driven by the response to climate change. The transition risk channel includes changing consumer demands and preferences in response to the effects of climate change.

Though climate change may still be catalogued as an emerging risk, it may be more representative to describe it as a risk driver with broad and diverse effects. Breaking down the climate change risk driver may present insurers with the opportunity to apply more conventional risk management techniques to what can initially appear to be an insurmountable issue. In this paper, Milliman’s Kyle Audley, Dana-Marie Dick and Natasha Singhal consider the current and developing regulation, in the UK and Europe, surrounding climate change-related risks, the risk identification and risk management practices available to insurers and examples of the key challenges faced by insurers in response to climate change.

Life (re)insurer ALM and Solvency II

In preparing for the upcoming 2020 Solvency II review an important area of focus for life insurers and reinsurers should be a reassessment of asset-liability management (ALM) strategies for long-term liabilities both from the perspective of legislative changes that are under consideration as well as shortcomings in practices that have already been highlighted by regulators. Firms should be assessing these issues for day-to-day solvency, the own risk and solvency assessment (ORSA) and overall risk management needs, bearing in mind the consequences for different types of business and the potential influence on business mix into the future.

In this blog post I highlight some of the key legislative changes currently under consideration regarding the treatment of long-term liabilities, including those that may affect each of the following areas which are important in the context of ALM:

  • The methodology and assumptions underlying the extrapolation of the risk-free rate curves for varying currencies including the last liquid point (LLP), the rate of convergence to the ultimate forward rate (UFR) and the level of the UFR itself
  • The volatility adjustment (VA)
  • The matching adjustment (MA)

I also summarise public feedback from the European Insurance and Occupational Pensions Authority (EIOPA) and national regulators regarding ALM best practices.

The long-term guarantee measures under Solvency II

As part of the final set of rules established prior to the commencement of the Solvency II regime in 2016, a set of measures was introduced regarding the treatment of ‘long-term guarantees’ or LTGs. These measures, commonly referred to as the ‘LTG measures,’ comprised the extrapolation of the risk-free rate, the VA, the MA and the transitional measures for the risk-free rate and technical provisions (TRFR and TTP).

Progress is well underway towards the review of the LTG measures, as originally envisaged to happen by the end of 2020 under the Omnibus II Directive. EIOPA has been charged with overseeing ongoing experience with regards to the LTG measures, publishing an annual report for each of 2016, 2017 and 2018. These annual reports are intended to be a key input informing the wide-ranging review of Solvency II. Indeed EIOPA is specifically required to submit an opinion on its assessment of the application of the LTG measures by the end of 2020.

Additional requests from the European Commission (EC) as part of the review process now make it clear that a point of focus regarding the LTG measures will be a reassessment of their appropriateness, particularly taking into account ALM practices of life (re)insurers.

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Translating cyber risk into a language the board understands

For many senior executives today, the jargon of cybersecurity may feel like hieroglyphics, a mysterious language that requires translation. Additionally, there is a lack of consensus on how to categorize cyber within a risk taxonomy. The insurance sector often views cyber as a financial risk, specifically a subset of insurance risk due to underwriting of policies. Banks may view cyber as a type of operational risk, while other industries may see it altogether as a strategic or standalone risk.

This lack of a common vernacular creates a communication barrier between cybersecurity experts and the board. To bridge that gap, a new approach is required that makes it possible for stakeholders on both sides of the table to speak the same language. In this paper, Milliman’s Chris Harner and Chris Beck discuss the language of cyber and why it’s important to translate this complex, technical language into financial terms.

How to lower defense costs using analytics (infographic)

For medical malpractice insurers, market pressures continued in 2018 despite overall profitability, according to a May report by AM Best. One way to combat potential headwinds is by lowering defense costs using advanced analytic techniques. In 2017, NORCAL Group began using Milliman’s Datalytics-Defense®, which uses proprietary data-mining techniques to analyze companies’ defense cost invoices and produce actionable insights. The results from the case study shown in the infographic below demonstrate the extent NORCAL was able to reduce its defense costs, all the while maintaining its overall claims-with-payment ratio.

Sharing economy presents risks and opportunities for P&C insurers

The on-demand sharing economy is providing insurance companies an opportunity to develop products for new lines of business. Home sharing, ride sharing, and fashion rentals are three new insurance exposures resulting from the economy. These new exposures present actuaries with several challenges when trying to reserve for their associated risks. In this article, Milliman consultant Dana Ryan discusses the property and casualty (P&C) insurance opportunities and risks of the sharing economy.

Will insurance-linked securities play a larger role for captives?

The insurance-linked securities (ILS) market has overcome major catastrophe losses in 2017 and 2018, proving to be a reliable risk transfer instrument for insurers. While the market is now growing and expanding beyond natural catastrophe risk, ILS transactions sponsored by captive insurers have been relatively quiet in recent years—but may be poised to grow in the future. In this article, Milliman actuary Aaron Koch discusses the current insurance-linked securities landscape and how captives are using this segment.