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.