Climate risk: the challenge of pushing short-term thinking businesses to make long-term changes

Insurance can often be an industry centred on short-term thinking. Each year, Lloyd’s requires that its syndicates submit a one-year business plan for approval. While in theory some of these syndicates could be submitting this as only one part of a developed three or five-year plan, my experience in the market has shown that this is seldom the case. Insurance businesses rarely think more than one year ahead. Loss ratio, combined ratio, gross written premium, underwriting income—these metrics are evaluated on a 12-month basis.

This is one of the reasons why developing a business strategy that acknowledges climate change is such a daunting task for insurers. If we take away the science and look at this from a business management perspective, climate change is really no different than, say, organically increasing a business’s annual premium or significantly diversifying an insurer’s portfolio. All of these things take time. Organic growth requires changing your business incrementally, year on year, and focusing on the future, not just the present. Our response to climate change should mirror this. Making long-term changes, or adapting to climate change, requires assembling the building blocks one at a time. Sure, we can throw the rulebook out the window and make some drastic, immediate changes to our business strategy, but that approach is rarely successful.

Modifying our behaviours may help mitigate the effects of climate change. However, we cannot turn back the clock on human behaviour, and to some extent we must accept that our planet is not static and is constantly evolving. Some changes, such as global warming resulting from increased levels of greenhouse gases, can be linked to human behaviour. Others are simply the result of natural shifts in weather patterns. An example of this is the Sahara Desert. 6,000 years ago, this was a rainy, tropical area. Today, it is one of the world’s largest deserts. Stark changes like this take time. It could be two or three hundred years before we see the full impact the past century of human behaviour has had on our planet. However, we are sure to see some severe short-term events that will heavily impact insurers’ books. The world will look different in five to ten years and risk professionals have the responsibility to think in timescales that transcend the fiscal year. Those who refuse to adopt a long-term view will see this reflected in their long-term profits.

One of the greatest challenges posed by climate change is the acceptance that we are stepping into uncharted waters, and must therefore be willing to think outside the box. Over the past decade, an enormous amount of capital has been invested in the exposure management industry and US hurricane and earthquake models that claim to produce extremely accurate results. When I entered the industry in 2004, exposure management professionals were known as ‘catastrophe modellers’—our job was only to plug in the numbers and see what the models said. Our industry has evolved enormously since then. Today’s exposure management professionals generally look at the bigger picture. We accept that models are one part of the puzzle and come with some level of inaccuracy.

However, when addressing climate change, we must be even more diligent in investigating and challenging the predictions of catastrophe models. Models are based on datasets and when it comes to climate risk, history isn’t a perfect representation of the future. Evaluations must be the result of a combined process of risk assessment, analysis, and modelling, which requires years of exposure management experience. At Asta, we are committed to developing solutions for our clients that address the greatest challenges in the market. The depth of our expertise, combined with our ability to support effective exposure management across a range of business classes, systems and cultures, makes us ideally placed to assist syndicates with the management of emerging risks, such as climate change.

So, how do we as an industry alter our short-term mindset to accommodate the long-term changes that will result from climate change? Our next blog, which was published as part of Insurance Day’s recent special report on ‘climate change, will provide some potential answers and solutions to this question. Watch this space.