It’s a Risky World Out There

A conversation about global climate risk practices and developments Interview by Bryan Liu


This past June, intense Canadian wildfire smoke affected the northeastern United States, creating health concerns and affecting daily life with flight cancellations and school closures, among other disruptions. On June 5, New York City, home to more than 8 million people, became the most polluted city in the world. Recent regulatory developments, coupled with the physical impact of extreme weather events, have made climate risk top-of-mind for insurers across North America.

Insurance regulators have been busy establishing many requirements related to climate risk. For example, in Canada, the Office of the Superintendent of Financial Institutions (OSFI) issued a guideline on Climate Risk Management. The new guideline will require Canadian insurers to provide public disclosure on climate risk exposure and include climate risk scenarios in the annual Financial Conditioning Testing (FCT) stress-testing exercise. In Bermuda, the financial services regulator Bermuda Monetary Authority (BMA) issued a guidance note on the expectation for insurers to integrate climate change analysis into Self Solvency Assessment reports.

Timothy Cheng, ASA, CERA

Claire Booth, FIA, CERA
The Actuary Canada spoke with Claire Booth, FIA, CERA, and Timothy Cheng, ASA, CERA, actuaries with experience in the United Kingdom and Asia-Pacific markets, respectively. In this interview, they discuss climate risk practices, developments and management in these markets, and commentary is provided on how they compare to such practices, developments and industry standards in North America.

Tell us about yourself and your professional background—specifically the journey that led to your current role.

Booth: I am a consulting actuary on Milliman’s London Life team, with 10 years of experience in the areas of life actuarial valuations, modeling and enterprise risk management (ERM). Recently, I have been focused on the climate risk management space for insurance clients, which is a constantly evolving area as a result of external factors such as new regulation and the changing physical environment. It’s been interesting to see the industry respond to these challenges and help clients on their journey.

Cheng: I started my career at Mercer focused on employee benefits. Since 2019, I have pivoted my career toward sustainability, working for sustainability consultancies and most recently for HSBC on climate strategy and scenario analysis.

I have worked on projects such as climate stress testing; environmental, social and governance (ESG) rating and disclosure exercises (e.g., Dow Jones Sustainability Index); decarbonization; and net-zero strategies. Outside of the workplace, I am part of the steering committee of the Society of Actuaries (SOA) Catastrophe and Climate Research Program.

What are common physical and transition climate risks of concern in your region?

Booth: U.K. insurers are exposed to a variety of physical and transition risks. On the physical risk side:

  • A common concern is flooding. Recent studies by the Met Office indicate that heavy rainfall and severe flash floods could become five times more likely by end of the century. Coupled with rising sea levels and more of the population living in coastal areas, flooding risks could become more material.
  • Changes in temperature and more frequent heatwaves may lead to operational issues.
  • A secondary physical risk is the risk of increased mortality and morbidity rates in the long term as a result of increases in average temperatures, pollution and frequency of catastrophic events.

Transition risks are likely to affect insurer’s asset portfolios. Shocks to asset values could result from changing regulations and social and commercial patterns as the economy shifts to become low carbon. For life insurers, this is often the most proximate climate risk. Transition risks are particularly challenging because they could materialize extremely rapidly and are difficult to anticipate both in terms of timing and magnitude.

Other transition risks include liability risks from climate risk compliance issues and reputational risks arising from concerns around companies’ contributions to the transition to net zero.

But climate risks also present opportunities for insurers. As the economy transitions, there will be new types of investment opportunities, such as green bonds and climate-focused funds.

Cheng: In the Asia-Pacific region, physical risks vary significantly among different places. For example, coastal regions in South and East Asia (e.g., the Philippines, Indonesia and China) experience an average of four to five typhoons per year, while countries close to seismic areas, like Japan, are prone to earthquakes. Australia faces wildfires and heatwaves. Modeling physical climate risks in the region typically includes a multitude of perils, such as river and surface flooding, coastal inundation, tropical cyclones and wildfires.

Similarly, transition risks vary significantly based on different regulations in different countries. Particularly for developing markets, the transition risk is less significant. Carbon trading schemes have been introduced in China and Singapore, with the latter having carbon credits transacted in a global carbon trading platform. China has the largest electric vehicle market in the world and heavily subsidizes solar power generation. When we quantify future transition risks, the biggest drivers are carbon taxes and the transition away from fossil fuels.

Bryan Liu: Similarly in North America, physical risks vary significantly based on the specific region. For parts of the East Coast in Canada and the United States, hurricanes are a key physical climate risk. The Atlantic hurricane season, which lasts from the summer until the end of fall each year, averages more than $100 billion in annual damages. On the other side of the continent, drought and wildfires are critical climate-related risks.

Transition risks also are dependent on regulatory developments and business model changes. For North American life insurers, the consideration around transition risk is fairly similar to considerations in the United Kingdom. The impact of increasing regulations, particularly on the energy and oil and gas sectors, could play a key role in dampening the performance of insurers’ investment portfolios. This is perhaps of particular importance to Canadian insurers given the large portion of the economy that is based on the energy sector. 

What are the typical practices on climate management in your regions? Do practices vary significantly among companies? How about in other financial services sectors?

Booth: In the United Kingdom, the Bank of England mandated integration of climate-related risks into the ERM frameworks of banks and insurers by the end of 2021. Since then, practice around climate risk management has evolved as understanding of the risks has developed.

In the development of their climate risk management frameworks, insurers are putting in place governance structures around climate risk management, allocating responsibilities to the board of directors and senior management. Boards typically are responsible for overall climate strategy, setting risk appetite and ensuring that the risk management is sufficient.

The risk identification and assessment aspect of the ERM framework usually maps climate risks to current risk categories. For example, the investment risk category may include the transition risk of shocks to the market value of assets, and the operational risk category may include the risk of physical damages from extreme weather events.

As the Bank of England has prioritized climate change via stress testing exercises, such as the Climate Biennial Exploratory Scenarios (CBES), insurers are evolving and developing their climate scenario analysis capabilities. The CBES scenarios are built on those developed by the Network for Greening the Financial System (NGFS) and cover an Early Action scenario (gradual orderly transition and temperature increases limited to 1.8°C by 2050), Late Action scenario (climate transition is delayed until 2031 and temperatures stabilize at similar levels to the Early Action scenario), and the No Action scenario (no transition assumed and temperatures rise to 3.3°C by the end of the scenario timeline).

In terms of mitigation, life firms have been focusing on managing the risks in their asset portfolios by excluding certain assets, including climate considerations in their selection processes, setting limits on the carbon intensity of counterparties and engaging with counterparties to assess their climate change commitments and transition progress.

Cheng: Disclosure is a big part for companies. I would say for most companies, there is an ESG section in annual reports (more advanced ones have separate annual sustainability reports). It is mandatory that ESG information be disclosed for listed companies in some Asia-Pacific markets (e.g., Hong Kong, Singapore, Philippines and Malaysia). These reports typically contain qualitative descriptions like net-zero strategies and green initiatives and quantitative information like carbon emissions (more common to only disclose scope 1-2).

Typically, large corporations in the Asia-Pacific region tend to follow the Task Force on Climate-related Financial Disclosures (TCFD) framework as it is considered a clear global standard. However, since it is not mandatory yet, actual practices vary across industries and markets. The less common practices (publicly disclosed) are usually around climate scenario analysis (especially quantitative results) and carbon scope 3 emissions.

Banks are more advanced, as there were existing requirements from the banking authorities to conduct climate scenario analysis (e.g., Hong Kong Monetary Authority and Monetary Authority of Singapore) following the lead of CBES in the United Kingdom back in 2021. They all leverage NGFS scenarios. Other Asia-Pacific countries like New Zealand, Australia, Indonesia and Malaysia are starting to follow suit.

Liu: Overall, the North American insurance industry is behind its counterpart across the Atlantic. In the absence of detailed prescribed rules across the industry, practices vary significantly among companies. Like the Asia-Pacific market, large insurers tend to focus more on climate risk management efforts in areas of scenario analysis for own risk and solvency assessment (ORSA) exercises. For smaller companies, climate risk management may be limited to a small note in risk dashboards and reports.

What are the regulatory and nonregulatory drivers for improving climate risk management in your region?

Booth: Regulatory drivers are significant. As mentioned previously, regulation that covers climate risk management exists in the United Kingdom, and the regulators continue to make climate change a key priority. The key regulatory pressure at the moment is new rules around disclosure, with the majority of insurers required to produce TCFD aligned disclosures either already or in the next few years.

Given the increasing regulatory pressure to understand climate-related exposures, there is a demand for new models that can address the existing climate modeling challenges. Actuarial models typically do not cover a long enough time horizon and do not link climate variables (such as increased temperatures) to economic variables (such as interest rates and equity market performances).

Causal models that capture the interconnectedness of various climate and economic factors, such as Milliman’s modeling solution CRisALIS, are extremely useful tools for exploring and quantifying potential climate-related risks. Causal modeling allows the user to generate a forward-looking view of complex risks by examining the relationships among variables. In the case of climate, causal models are useful to understand and explore the dynamics of interactions among various factors to allow us to develop an understanding of possible future trajectories and climate tipping points.

Cheng: Regulatory policies in Asia-Pacific are strong and shape the behavior of companies. There are clear roadmaps on making TCFD mandatory for financial institutions in the coming years. Many banks and insurers are looking into climate scenario analysis seriously as quantitative disclosures are expected when TCFD becomes mandatory.

Other important drivers include the popularity of ESG ratings, like Carbon Disclosure Project (CDP) and the Dow Jones Sustainability Indices (DJSI) from S&P. In some of the rating questionnaires, there are criteria for companies to have robust climate management practices in place. Some examples include the following:

  • Climate scenario analysis (with disclosure)
  • Climate risks integrated into overall ERM framework and risk register
  • Climate issues to be discussed in board meetings

Liu: Similarly, new regulations are a primary driver in changing climate risk management practices for North American insurers. This spans various aspects such as disclosure, risk assessment and scenario analysis. While property and casualty (P&C) insurers traditionally have been assessing climate risk impact, new requirements put forth by regulators and other agencies such as the Securities and Exchange Commission (SEC), OSFI, BMA and National Association of Insurance Commissioners (NAIC) have pushed life insurers to develop modeling capabilities and put in place risk management frameworks that target climate risks.

Beyond regulatory requirements, other developments, such as increasing investor attention on ESG as well as broader ESG developments, have allowed insurers to implement a climate-based lens in investment portfolio analysis. Research by actuarial societies, such as the Canadian Institute of Actuaries (CIA) and SOA, has given insurers a good starting point to develop their climate risk management frameworks.

What are the main challenges companies face in developing comprehensive climate risk management frameworks?

Booth: Data is a big challenge. Similar to operational risk modeling, there is often a lack of available data. Where data is available, there often is a lack of standardization and, therefore, comparability. For example, to calculate the carbon intensity of a bond issuer, different data providers may have different calculation methodologies. Companies often rely on information from external providers. Without the right data, quantification and developing metrics can be challenging.

The nature of transition risks means that they are difficult to quantify and measure. This is in contrast to physical risks where models for catastrophe risks already exist. Transition risks could occur suddenly and are subject to tipping points (reaching a critical threshold with significant and/or irreversible change), while transition factors such as changes in attitudes and policy are difficult to assess or anticipate. This is where models such as CRisALIS can be useful to develop an understanding of the risk dynamics.

Cheng: Data is a big challenge many companies face. They lack information and will seek it from external vendors for climate models (e.g., NatCat) and weather databases. Sometimes the problem is that there is no historical data available for climate events that have not happened before in the region, like significant sea level rises, extreme heat in cold areas and the introduction of a carbon tax. It will be difficult to persuade stakeholders to take action today on these potential losses without credible data.

Other challenges relate to people. Difficulties in integrating climate risk practices and management strategies in the company, and employees’ lack of understanding of the subject matter and climate risk, are long-term transition risks. It is also easy for people to consider climate separate from the main business-as-usual processes, making it hard to integrate climate risk management within a broader ERM framework. A lack of buy-in from senior management, especially for more established and traditional family businesses, also could pose a challenge.

Liu: Similar to other markets, the North American insurance industry faces challenges pertaining to modeling and people. In recent years, significant resources have been allocated to financial reporting tasks, making it challenging to devote time and effort to climate risk management. On the modeling side, insurers also face the challenge of the long-term nature of climate risks. For example, in Canada, stress testing exercises may only cover five to 10 years, making it hard to incorporate the impact of climate risks.

What is your outlook on near-term and long-term developments of climate risk practices, management strategies and regulatory requirements in your regional markets?

Booth: In the short term, the current pressure is for insurers to prepare their first TCFD disclosures in line with regulatory deadlines if they have not already done so. Climate risk management is an iterative process, so in the medium to long term, we expect to see further refinement of practices, available industry tools and modeling, with best practices emerging.

Cheng: The practice of climate scenario analysis is gaining momentum rapidly in the financial industry. Regulatory climate stress tests for banks are becoming more frequent (up to biannual for some jurisdictions), and these will cover insurers eventually. Climate risk also is expected to be incorporated into ORSA exercises.

In addition, TCFD and ESG reporting requirements are important drivers, especially in the long term when disclosing more quantitative information will be mandatory. There are ongoing discussions on net-zero timelines and exits from fossil fuel markets in the insurance industry that also may play a role in how practices will shift in the future.

The topic of climate change resonates strongly with younger generations who are aware of the urgent need for action, so I would expect climate risk to be more broadly discussed in the workplace and a key agenda for the management team.

For companies that are beginning to consider climate risks, what are some of the first steps to take?

Booth: The development of an overall strategy for climate risks is critical for guiding your subsequent efforts. A well-defined strategy would help stimulate action throughout the company to manage the risks and consider the climate change impacts when making decisions. Setting a climate strategy involves establishing a board-approved climate ambition (which may include carbon emission targets); deciding how the organization can use its role as an investor, product provider and product purchaser to contribute to the net-zero transition; and defining what climate risks to accept, avoid or manage.

Cheng: Actuaries and risk managers should play an active role by starting the conversation around climate risks and looking at best practices from around the world (i.e., reading sustainability reports from industry leaders). I also would recommend looking at the stress testing results for insurers from CBES 2021, as there are quantifiable insights around ways climate risks and opportunities could affect insurers’ operations.

How can actuaries play an active part in these developments?

Booth: Modeling is naturally an area where actuaries can play a key role to meet the demand for estimating future climate impacts. The output of our work can help drive action and discussion around the steps needed to halt climate change.

Cheng: Actuaries can do the following:

  • Understand the latest climate trends from news and research reports.
  • Consider climate risk in your daily job (especially when you work with other nonfinancial risks like demographic shifts and policy changes).
  • Attend actuarial seminars and events—climate and ESG topics are common.
  • Read actuarial climate research from the SOA and others, and volunteer for the SOA Catastrophe and Climate Research Committee if you are really interested!
Claire Booth, FIA, CERA, is a consultant at Milliman’s Life and Financial Services Practice of Milliman in London. She has significant risk and capital management experience, spanning areas such as climate risk, Solvency II and causal modeling.
Timothy Cheng, ASA, CERA, is a manager of Climate Strategy and Scenario Analysis at HSBC. He has more than five years of experience working with insurers, consultancies and banks in areas of climate risk management and sustainability.
Bryan Liu, FSA, FCIA, is an actuary at Milliman’s Life and Financial Services Practice, providing ERM and M&A consulting services to clients across Bermuda, the United States and Canada. He chairs the SOA’s Actuary of the Future section and sits on the editorial board for The Actuary Canada.

Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries or the respective authors’ employers.

Copyright © 2023 by the Society of Actuaries, Chicago, Illinois.