By Torolf Hamm, Senior Director and Global Lead, Physical Risks, Climate Practice, at WTW
As the world heads towards global warming, potentially beyond two degrees 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 appropriately, organisations 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 organisation’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 extreme catastrophic events. Because of the lack of data and functionality limitations, traditional natural catastrophe modelling typically struggles to capture the wider financial impact due to external value chain interdependencies and operational disruption.
For example, during the 2021 flood event in Western Europe, water utility companies authorised 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 organisations 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 modelling that looks beyond organisational boundaries. Organisations should also be prepared to review publicly available emergency response procedures of utility companies to enhance the modelled 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 scrutinise the theoretical models and their underlying uncertainties, potentially in collaboration with academic or other external partners where an organisation does not have the skills sets required internally.
Smarter modelling means harder-working risk spend
Outsmarting natural catastrophe exposures exacerbated by climate change isn’t just about closing protection gaps. An evolved natural catastrophe modelling approach that is bespoke to an organisation and better reflects the potential impact of different climate scenarios, puts decision makers in the driving seat of what to spend on protection. By moving away from using a single natural catastrophe model to a more nuanced, multi-method approach, they are able to optimise their risk spend. 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. Organisations 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 modelling approach puts them in a much firmer position than those organisations 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 organisations need to factor these into how to assess their natural catastrophe risk. In fact, we’re seeing more organisations 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 a heavy rainfall event 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 modelling 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, organisations can better prepare and build resilience, ensuring they can maintain operations even when faced with complex and interconnected 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 organisation 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 prioritising 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 modelling approaches can also help inform conversations with insurance markets, help address coverage gaps and optimise 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 organisation. Quantifying the financial impact of climate-related risks in this way can both 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, realise organic growth and access capital.
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