By Wendy Kriz Evans, FIA, Principal at LCP
1. Climate change
The regulatory spotlight has long been pointed at this burgeoning crisis. From mandatory climate risk reporting for major UK corporations, to Lloyd's insistence on robust risk assessment models tailored to current climate conditions, the beat of the regulatory drum grows louder with each passing year.
We have found climate scenarios to be a key element in understanding the potential impact of climate change. A recent paper on climate scenarios by the IFoA and University of Exeter stands out in the sea of articles on climate change in insurance. The paper is provocatively titled 'The Emperors New Climate Scenarios’ and casts doubt over the adequacy of existing climate scenarios used by financial institutions. (Note that the authors have just followed this up with a new paper called ‘Climate Scorpion – the sting is in the tail’ which explores the idea that Earth’s climate may be more sensitive than we thought.)
Challenges abound, from concerns over significant risk underestimation, to an over-reliance on regulatory scenarios, to firms failing to consider tipping points within their climate scenario analyses (a tipping point is a critical threshold that, when crossed, leads to large, accelerating and often irreversible changes in the climate system).
Firms should invest time now into developing climate scenarios that are appropriate for their risk profile. A great first step on this journey is to improve communication around scenarios, including communication of limitations.
2. Geopolitical risk
My second hot topic prediction is geopolitical risk. The potential conflict in China and Taiwan continues to be talked about in the media – with news coverage increasing further throughout March 2024.
Reports mention a shift in the way China talks about Taiwan, pointing towards a gearing up for war. While tensions between China and Taiwan continue to mount, speculation is also growing about a new Cold War between China and the USA (and potentially other Western countries).
The immediate impact on insurers of an increase in geopolitical risk in these areas is likely to be a stepping up of mitigations already in progress. For example, further reducing insurance exposures in China/Taiwan, increasing premiums for insureds exposed to the areas and tightening terms and conditions for exposed renewing policies. While all classes of insurance with exposure in China/Taiwan are potentially affected, the classes with the largest impact are war, aviation and property.
Some may see increasing risk as an opportunity. While this could be a risky strategy, there could be significant opportunities for the brave. For example, if some insurers pull out of China and/or Taiwan completely, there’s a greater share of potential business (and profit) for those willing to take on the increased risks.
And as part of this, firms should be considering how the changes they are making in response to heightened geopolitical risk should be reflected in their modelling approaches.
Other known geopolitical threats include Ukraine/Russia, Iran, and North Korea. With the wide range of potential threats, firms should ensure that they have considered how geopolitical escalations might affect all risk areas across their business.
3. Market risk
My final prediction is market risk. Inflation may be more under control, but the (relatively) recent dramatic changes in inflation and interest rates mean model gremlins may have come out of the woodwork. Our models (capital, ESG, pricing) were mostly developed in a low interest rate and low inflation environment. This means model issues and limitations may only be coming to light in the new economic environment.
Market risk is often modelled using external ESG models. You may consider it necessary to adjust ESG output to ensure that the modelling aligns with your internal view of inflation. Or you may decide to stick with the external expert view. As ever, whatever you choose to do should be justified.
Recent high inflation has now had more time to flow through into secondary areas. So, it is a good time to think about reviewing inflation in areas such as reinsurance and longer tailed lines. For each line of business, do you need to revisit your view on the key drivers of inflation, how long high inflation may last, or how volatile might it be?
So, there you have it - my top three predictions for regulatory hot topics are climate change, geopolitical risk and market risk. There were many other topics I could have chosen including: man-made catastrophes, use of AI, cyber risks (potentially driven in part by geopolitical risk described above), recession, and outwards reinsurance placement. I will leave it you to judge my predictive prowess later in the year…!
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