Tested to the limit by the pandemic and buffeted by regulatory change, today’s insurance risk managers are no strangers to big challenges. So what’s next on the risk agenda?
In fast-evolving times for insurance companies, we see the risk management function turning its attention to four priorities.
1. Managing climate risk
Perhaps the biggest challenge facing insurers is to fully understand their exposure to climate risk, which means being able to quantify, manage and report on the potential impacts of climate change. With local regulations now emerging to capture climate risk on the balance sheet, the International Sustainability Standards Board is also developing its own set of sustainability standards for disclosures to stakeholders.
Climate change increases risk for the insurance industry in three ways:
- First, the move to a lower-carbon economy exposes insurers to transition risks. In other words, they risk losing value on investments in – or insurance for – industries that are heavily dependent on fossil fuels. By actively “decarbonizing” their investment and underwriting portfolios, firms can not only reduce transition risk but also drive more sustainable investment.
- Second, climate change exposes the assets they cover for policyholders to physical risks such as storm damage, flooding and other impacts of extreme weather. Firms paid out $130 billion in weather-related claims in 2021 alone, so it’s critical they can quantify, manage and disclose these risks.
- Third, Property and Casualty (P&C) insurers in particular are more exposed than ever to liability risks as parties that suffer loss from climate change make claims against those they believe are responsible. As this kind of climate litigation will only increase, P&C insurers need to understand their potential liability for future claims.
The good news is that some leading insurance companies are already ahead of sustainability regulations and managing these three risks. This year, many more insurers will be stepping up to build climate risk management frameworks and take action.
2. Moving to the cloud
Lockdown conditions in the pandemic accelerated the need for fast remote access to insurance risk management technology, and cloud-based solutions provided a ready answer. Now, as insurers come out of the pandemic and look to ensure the long-term resilience of their operations, the cloud continues to form an integral part of their plans.
But besides accessibility, there are three more key reasons why the future of technology consumption lies in the cloud:
- One, use of the cloud in general reduces your carbon footprint. The leading cloud vendors already operate highly efficient modern data centers and servers – and two of these top providers, Amazon and Microsoft, both have goals to run their cloud services on 100% renewable energy by 2025.
- Two, as well as offering cleaner solutions than insurers could run in-house, the cloud allows firms to pay only for the compute resources being consumed rather than wasting money and energy on powered-up but idle hardware.
- Three, the cloud gives insurers flexibility. In the pandemic, cloud-based insurance risk management technology didn't just provide remote access but also the elasticity firms needed to run multiple complex models and scenarios. Predicting the impact of COVID-19 on mortality, morbidity and the economy took a lot of compute power, which insurers on the cloud could ramp up and down rapidly in the cloud.
For faster calculations, management information and strategic decisions, the cloud certainly proved its worth in the pandemic. It also went mainstream so fast that its mass adoption was accelerated by three to five years.
3. Embracing regulation
No commentary on insurance risk management would be complete without a mention of IFRS 17 and US GAAP LDTI. Insurers have worked on these accounting standards for years, and for the first wave of firms at least, the end of 2022 marks the official start of new reporting requirements.
Beyond meeting the implementation deadline, though, a key trend for insurers this year is thinking about how to turn compliance into value. I wrote many years ago about the benefits of IFRS 17, and I still believe that implementing the standard brings added advantages to all stakeholders.
By upgrading their systems, adapting their processes and changing the way they think about valuing insurance contracts, insurers around the world are transforming how they run their businesses, make management decisions, price products and more.
Why just aim for compliance when you can embrace regulation and reach for optimization?
4. Improving risk management
Better risk management might sound like an obvious goal for risk managers, but bear with me. There’s a clear trend of insurers getting back to basics and upping their game on risk management.
The last two years of the pandemic have really demonstrated the value of strong insurance risk management as actuarial models helped the industry through one of the most volatile and uncertain periods of our lifetime. But the unprecedented events also revealed the need for insurers to improve risk management practices, governance and modeling – some firms to a greater extent than others.
The pandemic particularly highlighted the multiple shortcomings of solvency models. Even when pandemics were considered as part of solvency regimes, they were at best viewed as affecting mortality and morbidity and therefore mainly life and health contracts. Regulators missed the fact that lots of claims would ultimately be made on P&C policies for travel disruption and business interruption.
As a result, most solvency models failed to capture many of the impacts of government-enforced lockdowns on society. They also overlooked: interconnections between additional mortality claims, falls in asset values and lower yields; how the additional mortality varied by age; and the potential impacts of COVID-19 on morbidity, long-term physical health and mental health.
Of course, no model will ever predict everything that will happen and the next pandemic will likely be very different to this one. But clear lessons have been learned – not least that insurers must incorporate more stress testing into their internal risk management frameworks with more combinations of stresses and more reverse stress testing. It’s also evident that, thanks to the lessons learned, regulations will change too.Keep up to get ahead
Together, all four of these latest trends underline that insurance risk management is an unstoppably dynamic process that must always be adapted and improved. Regulation may be a common driver for industry improvement, but insurers should also make continuous improvements part of their company strategy.
Staying on top of risk and one step ahead of competitors transforms insurers into leaders. And with that kind of forward-looking approach to risk management, you’re always more than ready for the next big challenge.