Actuaries Adapt to Climate Change Using New Tools

Actuaries Adapt to Climate Change Using New Tools

Multiple Authors June 01, 2017 Posted in: Blog Posts, General, Insurance / Insurers, News

Co-authored by Tyler Shalitis and Nicole McArdle.

It’s concerning that many indicators of climate change like global temperature or sea levels continue to rise. Fortunately for the insurance industry, actuaries are also rising to the challenges posed by climate change. One recent example is the creation of the Actuaries Climate Index (ACI) and the forthcoming Actuaries Climate Risk Index (ACRI). These indices were created jointly by the American Academy of Actuaries (AAA), Canadian Institute of Actuaries (CIA), Casualty Actuarial Society (CAS) and Society of Actuaries (SOA) to help actuaries address the challenges climate change has created.

These tools are necessary to respond to upward trends in weather-related losses. For instance, Munich Re has reported that since 1980, weather-related losses have increased nearly four-fold. The ability to quantify climate change is important not just because of increasing losses, but also because shifting climatic conditions could lead to unexpected types of losses like property damage in new regions. Such unforeseen losses may, in turn, necessitate new products or the redefinition of current products in order to adapt. There are also growing concerns over which entities could be held liable for future climate change costs. Regulators will also face challenges: Will there be sufficient solvency, liquidity and capital in the marketplace to finance these new risks? Because of these and other issues, regulators will also need to consider whether to require a statement of catastrophic or extreme weather risk by the enterprise risk manager, actuary or risk modeler. 

The ACI is one tool which has recently become available to actuaries. It uses a reference period of 1961 to 1990 for United States and Canadian climate data which serves as a benchmark to evaluate how much the climate has shifted. Six carefully selected climate variables are averaged together to create the ACI: high-temperature events, low-temperature events, heavy rainfall, drought, high wind and sea level. The ACI can also be broken down by component or region to provide more specific information based upon user preferences. The graph below shows the total ACI for the contiguous United States using monthly data from the beginning of 1961 to summer 2016. An overall increasing trend can be seen since the reference period, with a higher index representing an increased occurrence of extreme weather. 

In addition to the ACI, the ACRI index is currently in development and will relate loss data to climate data, providing a tool to evaluate the risk of climate change for a specific region and by individual line of coverage. The ACRI will be a regression of climate data on loss data, resulting in a model that predicts insurance risk as the climate shifts. As the above chart illustrates, climate can vary considerably from one year to the next, move in a cyclical fashion and show trends. The ACRI will, therefore, be useful for pricing since it will be better equipped to anticipate climate changes than extrapolated historical loss data. It can also factor into portfolio diversification since the ACRI can be used to evaluate which regions or lines carry higher or lower climate change risk levels. 

Climate change means additional medium- to long-term uncertainty for the insurance industry. We anticipate that these new resources will enable actuaries to proactively deal with the challenges looming on the horizon. The ACI and ACRI can help provide valuable insight into what is happening with climate change and can be used in a variety of insurance applications, including pricing and portfolio diversification. Actuaries can’t stop the climate from changing, but they can keep doing what they have always done best – adapt and develop new methods to help the insurance industry continue to manage risk and thrive.

Tyler Shalitis is an Actuarial Analyst with Pinnacle Actuarial Resources, Inc. in the Bloomington, Illinois office. He holds a Bachelor of Science degree in Actuarial Science from Illinois State University and has experience in assignments involving loss reserving, loss cost projections and group captives. Tyler is actively pursuing membership in the Casualty Actuarial Society (CAS) through the examination process.

Nicole McArdle is an Actuarial Analyst with Pinnacle Actuarial Resources, Inc. in the Chicago, Illinois office. She holds a Bachelor of Science degree in Actuarial Science from Illinois State University and has experience in assignments involving loss reserving, loss cost projections and group captives. She is actively pursuing membership in the Casualty Actuarial Society (CAS) through the examination process.
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