Climate Risk in Insurance: The Real Challenge Is Not Identifying the Risk

Climate Risk in Insurance: The Real Challenge Is Not Identifying the Risk

Most insurers no longer need to be convinced that climate risk matters. The terminology is familiar. Physical risk, transition risk, liability risk, scenario analysis, emissions, disclosures and climate resilience are now part of the insurance conversation. The harder part is making those concepts work inside the business.

Climate-risk implementation often starts with a policy, a risk register entry, a Board presentation or a disclosure exercise. All of these have a place, but they do not necessarily change how the insurer manages risk. A policy may remain disconnected from underwriting. Scenario analysis may sit outside the ORSA. A sustainability disclosure may be prepared without a reliable evidence trail. A Board paper may describe climate risk without showing where the exposure sits, whether it is changing or what management is doing about it.

The real implementation challenge starts there. Climate risk is not best managed as a separate risk sitting beside the enterprise risk management framework. In practice, it acts through risks the insurer already manages. Physical risk may affect property accumulation, motor flood claims, business interruption, health claims utilization, repair costs, claims inflation and reinsurance recoveries. Transition risk may affect investment values, sector concentrations, underwriting appetite, customer behavior and the future insurability of certain activities. Liability risk may emerge through litigation, coverage disputes, directors’ and officers’ exposures or allegations of misleading environmental claims.

What matters is where climate risk enters the insurer’s existing risk system and how it changes the behavior of underwriting, claims, reserving, reinsurance, investments, liquidity, capital and solvency.

Climate-risk work should therefore start with materiality rather than sophistication. There is often pressure to move quickly into complex models, scenarios and metrics. But where exposure data is incomplete, inconsistent or poorly owned, the output can look more precise than the evidence allows.

The first step is often more basic. Which parts of the underwriting portfolio are most sensitive to physical events? Which investment sectors or geographies may be more exposed to transition risk? Where are concentrations building? What information is actually available? Where are proxies being used? How much confidence should management place in the result?

It is not unusual to see an insurer reporting on climate risk while still lacking geocoded property data or a clear view of flood concentrations across the portfolio.

A well-structured materiality assessment or exposure heatmap, with clear assumptions and limitations, can be more useful than a sophisticated model that cannot be explained, refreshed or defended.

The same discipline is needed in scenario analysis. Describing a possible future is not enough. The analysis has to connect the scenario to exposure, financial sensitivity, capital or liquidity implications and management action.

Take a flood scenario. The relevant questions go well beyond the initial estimate of claims. Exposure accumulation, policy terms, deductibles, reinsurance retentions and program structure, recovery timing, reinsurer counterparty strength, claims-payment liquidity and the possible effect on solvency may all matter. Transition scenarios raise a different set of questions, including asset repricing, credit spreads, concentration, underwriting appetite, customer transition and possible changes in future business volumes.

The result does not need to be falsely precise. It needs to be good enough to support a decision.

Board reporting is another area where climate-risk program can become too narrative. Reporting that simply confirms the issue is being monitored adds limited value. The Board needs to see where exposure is increasing, which indicators are outside appetite, what data remains unreliable, which assumptions are being used, what actions are overdue and what decisions are required.

In practice, climate reporting works better when it resembles normal risk reporting rather than a sustainability brochure. Clear ownership, indicators, thresholds, escalation routes, action tracking and a regular refresh cycle all matter. It should also distinguish between results based on validated data and those that still rely on estimates or proxies.

External disclosure should then come out of this risk process rather than stand in for it. Weak climate disclosures are often not mainly a writing problem. More often, they reflect gaps in governance, ownership, data lineage, controls or the link between climate risk and the insurer’s financial position.

When the underlying operating model is strong, the disclosure is easier to produce and easier to defend. Where it is weak, polished wording can create more risk rather than less.

Climate-risk implementation becomes useful when it stops being treated as a separate sustainability exercise and becomes part of how the insurer understands exposure, sets risk appetite, evaluates resilience and makes decisions.

The objective is not to create the most sophisticated climate model. It is to build a process that management can operate, the Board can challenge and the organization can support with evidence.

Disclaimer: The information presented in this article is intended for general professional discussion and does not constitute actuarial, accounting, legal or other professional advice. Specific circumstances should always be assessed before relying on the concepts discussed.