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How to think about climate change risk management in 2023

20 July 2023 Ronald Richman, Chief Actuary at Old Mutual Insure

Climate change is one of the most pressing challenges of our time, and its impacts are being felt around the world. While some strides have been made in understanding climate change risk management, we are nowhere near dealing adequately with it. And yet, it is a significant area that requires attention.

The trends

The Actuaries Climate Indices indicate that extreme weather and other climate impacts are on the rise across North America, Canada, and Australia, and this trend is also reflected in experience in South Africa. Old Mutual Insure has observed that the frequency of catastrophe events increased by around 50% in the decade from 2012-2022 compared to the preceding decade. Considering the severity of these events, the average annual size of catastrophe claims has increased ten-fold in the same period, due to extremely destructive events such as the Knysna fires and the KZN floods. Along with these major catastrophes, we are also seeing an increasing frequency of smaller destructive events, sometimes in regions with little historical record of similar occurrences. Finally, our data clearly indicate a strong causal link between excessive rainfall during the La Niña climate phenomenon, which has been active for the past 3 years, and damage to both personal and commercial property.

Climate change risk management against this background

A useful starting point when analysing risks arising from climate change is to consider the three major categories of risk: physical risk, transition risk, and miscellaneous risks. Physical risk is the interaction of all our assets as individuals, companies, or countries with the physical environment. It includes acute risks, which are risks that have increased in observed frequency and severity, such as floods or wildfires. Transition risk refers to the impact of market shifts away from fossil fuels on stocks, bonds, and other financial assets. Meanwhile, miscellaneous risks such as legal risk and insurance risk also need to be considered.

In South Africa, there is a need to pay particular attention to acute physical risks such as floods and fires, which have become more likely in recent years.

To effectively manage these risks, we need to develop more sophisticated models that can predict the impact of climate change on different regions and industries. This requires collaboration between scientists, policymakers, and industry leaders to gather data and develop effective strategies.

The insurance industry is already playing an important role in building capabilities and servicing claims to help the most vulnerable people affected by these risks, and is making strides in better understanding the risks presented by climate change.

Traditionally catastrophe models have been used to map out the likelihood and expected impact of floods, but more detailed and granular models are needed. Recently, two new models that address this need have come online, which is extremely promising.

In addition, the insurance industry is already tracking sea level change as part of climate modelling initiatives. The risk with low lying areas like coastal towns means that changing sea levels will have a significant impact on property in these areas, particularly when events such as storms occur.

At Old Mutual Insure we are actively managing our climate change risk exposure through a program of data and actuarial analytics, designed to help quantify the trends in climate-related weather events and to enable the company to more accurately quantify and price risk. One example of this is a research project being performed jointly with local and international universities which looks to link micro level climate data with insurance policy experience. These links have been built using cutting-edge machine and deep learning techniques. This is proving to be a very useful way of understanding these risks.

Companies and governments can follow a similar process of building an understanding of climate impacts on their business by investigating how climate impacts have manifested in the past and forecasting how the changing climate is likely to modify these going forward. Once risks have been quantified, mitigating actions such as improved drainage systems to reduce flood severity can be considered and the financial benefits of these compared with the implementation costs. As an example of building wider understandings of climate risks, the Climate Change Committee run by the Actuarial Society of South Africa will aim to develop a South Africa specific climate index to help build an understanding of how these phenomena are affecting us locally.

In this context, it is also important to consider the impact of climate change on different regions of the country, such as the increased risk of drought and wildfire in the western part of South Africa. While there is some comfort in having more rainfall in other parts of the country, the fact that different regions are moving in different directions is concerning.

Managing climate change risk is not just a matter of developing new products and models. It also requires communication and education to help people understand the risks and make informed decisions about where to live and invest. For example, while the insurance industry responds to help those impacted following devastating floods and fires, if this is in a high-risk environment, it doesn’t solve the problem if people choose to rebuild in these areas. We need to communicate the risks and discourage building in areas that are prone to risks such as floods or landslides. The UK's national flood insurance program, Flood Re, offers insurance only to houses built up to 2019, which may serve as a model for other countries. However, this is difficult to do in a country such as South Africa. Nevertheless, education and information will go a long way in addressing this challenge.

We also need to invest in public-private partnerships to build the capabilities of the insurance industry and develop new products that can provide cover for the most vulnerable communities. This is particularly important in regions like South Africa, where natural disasters such as floods and droughts are becoming increasingly likely.

Thus, there is a need to act and put funding behind our thoughts to make a practical impact. This is where government can make a crucial difference.

Ultimately, managing climate change risk is a complex and multifaceted challenge that requires action at all levels of society. From individuals and communities to governments and industry leaders, we all have a role to play in building a more resilient future. By working together and developing effective strategies, we can manage the risks associated with climate change and build a more sustainable and prosperous world for future generations.

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