To outsmart the uncertainties posed by complex and related physical climate risks, organizations need to consider whether their current approach to modeling and assessing natural catastrophe is fit-for-purpose.
As the world heads toward global warming potentially beyond two degrees Celsius by 2050, we're already seeing greater volatility in weather-related natural catastrophe events, as well as an increased impact of chronic hazards, such as heat and cold stress. This is leading to greater uncertainty in economic losses and insurability.
By better understanding and quantifying the true cost implications of climate-amplified natural catastrophe risks, organizations can better prepare for the risks. This may mean checking they are not over-reliant or misinterpreting catastrophe risk models to ensure they avoid gaps in their organization's protection.
Traditional models leaving businesses exposed
Some traditional models for quantifying natural catastrophe risk are leading businesses to potentially miscalculate or underestimate their exposure to catastrophic events. Due to the lack of data and functionality limitations, traditional natural catastrophe modeling typically struggles to capture the wider financial impact due to external value chain interdependencies and operational disruption.
For example, during the 2021 flood in Western Europe, water utility companies authorized water management interventions on several major rivers. This prevented catastrophic dam failure as part of the emergency response procedures for severe/low likelihood events but increased the severity of flooding further downstream. We understand some private sector organizations did not factor these amplifying issues into their risk management and risk financing strategies, having based their decision-making predominantly on theoretical models and their own operational resilience.
Such cases illustrate the importance of moving away from relying solely on theoretical models and instead using a combination of "what-if" severe event scenario stress testing, risk engineering and theoretical modeling that looks beyond organizational boundaries. Organizations should also be prepared to review publicly available emergency response procedures of utility companies to enhance the modeled loss perspectives for flood risk of the theoretical models.
Getting these wider perspectives can enhance a company's ability to understand, quantify and manage the impact of severe events that are becoming more frequent due to climate change. This may also involve revisiting recent and historic natural catastrophe events, claims histories and the lessons learned to better evaluate and scrutinize the theoretical models and their underlying uncertainties, potentially in collaboration with academic or other external partners where an organization does not have the skills sets required internally.
Smarter modeling means harder-working risk spending
Outsmarting natural catastrophe exposures exacerbated by climate change isn't just about closing protection gaps. An evolved natural catastrophe modeling approach that is bespoke to an organization and better reflects the potential impact of different climate scenarios, puts decision makers in the driver's seat of what to spend on protection. By moving away from using a single natural catastrophe model to a more nuanced, multi-method approach, organizations are able to optimize their risk spending.
That's because a wider, clearer view on a company's risks will clarify what does and doesn't represent good value on insurance markets. Organizations will have better insight on questions like: Is my risk worse or better than my peers and, if so, why? They will also know how to better attract capital to their risk.
In a fragile insurance environment, evolving a company's modeling approach puts them in a much firmer position than those organizations that lack a clarified, data-driven view of their risks.
Secondary perils and the amplifying effects of climate change
A 'secondary' peril is a natural hazard that typically leads to small or mid-size damages compared with primary perils such as earthquakes or hurricanes. However, secondary perils, such as landslides following heavy rains or flooding, can often be as damaging as the primary events, meaning organizations need to factor these into how to assess their natural catastrophe risk.
In fact, we're seeing more organizations needing to address how perils such as landslides can be triggered by primary events like earthquakes, floods and tsunamis. Such hazards introduce additional layers of risk that traditional catastrophe models often don't capture.
For instance, a primary event like heavy rainfall may not only cause immediate structural damage but lead to landslides that block access routes, disrupt supply chains and prolong business interruptions. This can lead to further damage to the critical infrastructure and hinder recovery efforts.
That's why strengthening physical climate risk resilience means incorporating scenario testing and stress testing beyond traditional catastrophe modeling to gain that crucial, more comprehensive view of a company's risk exposures, including the potential impacts of secondary perils.
By understanding these compounded threats, organizations can better prepare and build resilience, ensuring they can maintain operations even when faced with complex and connected challenges.
To get ahead of natural catastrophe and physical climate risks today, scenario testing has a valuable role to play. By combining traditional catastrophe and climate analysis with additional stress testing, catastrophe risk engineering and scenario testing, an organization can get a more robust risk management view based on a deeper understanding of their risk profile and impacts across their value chain.
In some cases, this can lead to the business prioritizing non-insurance risk mitigation controls and action plans such as business continuity plans, recovery plans and crisis management readiness, rather than relying on traditional insurance, to improve resilience.
Advanced modeling approaches can also help inform conversations with insurance markets, help address coverage gaps and optimize decisions on risk financing and transfer. This could lead to alternative risk transfer and parametric solutions, depending on a company's risk tolerance, particularly when sufficient capacity is a challenge.
Risk managers looking to take a more strategic role can also leverage methodologies that quantify the current and future value of their company's assets and explore how investors view the organization. Quantifying the financial impact of climate-related risks in this way can enable a better response to climate risks and opportunities (while also potentially meeting certain climate disclosure requirements) and inform strategic conversations on the business's future ability to achieve targets, realize organic growth and access capital.
