Participants of a recent YAP Climate Workshop were asked to cast their minds forward to 2025 in a fictitious scenario where the small town of Derby, WA – now 'New Derby' – is a similar size to Darwin with a population of 100,000.
"We, as young actuaries, should aim for further understanding of the cause and effect of climate change and how we can better incorporate it into our work to find solutions for the increased financial costs we will face."
The plan for New Derby included building 5,000 new houses, an airport, a 400-bed hospital and an expansion of its existing pier and ship loading facilities. With a plan of this size and the weather conditions the town is subject to, we, the participants, were asked to brainstorm points related to the costs, time frames, weather risks, resilience methods and insurance coverage for each of New Derby’s assets.
While weather events are generally taken into consideration through catastrophe modelling, they do not directly take climate change into account. So we were also asked to consider the impact of climate change on this plan and how an insurance company might decide to approach the risk. Each group, with the help of climate change science researchers Earth Systems and Climate Change Hub, came up with insights and presented their ideas to the crowd.
I’ve included some of the main take-aways from this event as I cannot fit in all of the great ideas within this one post-event write-up. As the organisers probably intended, we were all left with more questions and ideas than we could come up with answers. This highlights the importance of the issue for the financial sector and the need for further investment of research and time.
Insurance Coverage for the New Derby
The insurance coverage varied for each asset and individual home. Derby’s exposure to natural weather events will most definitely be reflected in the pricing at a risk level. We thought the most important cover types to Derby were buildings, contents and business interruption. Buildings and contents are expected to be impacted due to damage from storm, cyclone, high tide or any other natural weather event. Business interruption insurance will also price with the same weather considerations as it will be expected to encounter frequent occurrences of business interruptions in the town. The port, airport and hospital will most likely be covered by a syndicate type insurance as we do not imagine one local insurer opting to take on all the risk.
"The frequency of natural weather occurrences might mean that insurers could possibly choose to ‘price-out’ of the market for Derby, leaving residents and business owners with no affordable insurance options."
We can see this has already happened to some degree in the Australian insurance market based on the ongoing Northern Australia Insurance Inquiry by the ACCC since May 2017.
To add some further complications to the scenario, when do we include the impact of climate change? Given there is already a large build-up of natural hazards risk, what will happen once we start to include the impact of potentially higher losses in the future?
Pricing for Resilience
It is not only in the interest of the insurer to have a resilience plan in place, but also for the home-owner, tenant, business owner, etc. Resilience is important for everyone as it impacts living standards. But who should be responsible for paying for resilience? We can see the direct benefit for all parties, but who is responsible for the cost?
Furthermore, are insurers even adjusting their pricing for resilience measures? If insurers do not reduce the premium for home and business owners who undertake resilience measures, then there is little direct financial incentive for owners to invest in resilience.
Building for Destruction
Most resilience measures will result in higher building costs. As the risk of catastrophes increases, that cost will also increase. Perhaps it may be a better idea to build destructible houses that are cheaper and quicker to rebuild? Depending on the frequency and severity of events, this might be a cheaper option in the longer term.
Risk Rating vs. Community Rating
The increasing amount of data we have access to has allowed insurers to price on an individual risk level where home owners can see significant differences in premium. For example, homes closer to the coast in Derby who have a greater exposure to storm surge may receive a significantly higher premium loading than homes further inland. To make insurance affordable for everyone, the concept of community rating was raised where everyone will be charged the same amount regardless of location – similar to how health insurance premiums do not differentiate between low risk healthy young people and high risk less healthy older people. However, will someone at the top of the hill be okay with paying a higher premium to subsidise the higher losses of someone living at the bottom of the hill? As risks increase under climate change and insurers get better at risk pricing, these questions of fairness will arise more and more.
To conclude, this workshop highlighted the impact of climate change on the financial sector and how we have more questions than answers when it comes its effects. Despite access to sophisticated catastrophe and natural peril modelling, adding climate change into the mix adds a new level of “unknown unknowns”. We, as young actuaries, should aim for further understanding of the cause and effect of climate change and how we can better incorporate it into our work to find solutions for the increased financial costs we will face.
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