Preparing for the Future

With the Australian Sustainability Reporting Standards (ASRS) effective for reporting periods beginning 1 January 2025, insurers are now required to consider climate-related risks and opportunities over projection horizons that may extend far beyond current business planning periods. The ASRS mandates that insurers perform scenario analysis and assess the financial impacts of climate-related risks and opportunities.  Such disclosures will necessitate significant input and modelling from various functions within the insurance sector, particularly from finance and actuarial departments.

For actuaries, the ASRS brings specific challenges and opportunities. There will be an increased focus on climate risk assessment and its financial implications, necessitating new modelling over longer time horizons and forecasting of climate-related risks and collaboration with other business units and decision makers to ensure the successful management of climate risks. Actuaries will need to ensure that assumptions and judgements used to inform climate risk identification and quantification are consistently applied across existing valuation and pricing processes and advice.

KEY AREAS OF IMPACT FOR ACTUARIES

Broadly, there are six key areas where actuaries would be involved in helping their organisation prepare for the ASRS. Below are the key considerations that actuaries should address in each area to successfully navigate these new requirements:

MATERIALITY

Actuaries should play a role in assessing the materiality of climate-related risks and opportunities, leveraging their expertise to quantify potential impacts and guide strategic decision-making.

• Segmentation of Risks and Opportunities: Collaborating with various business units, including the risk and finance functions, to build out a register of possible future climate related risks and opportunities, and assign probabilities to outcomes to assess if impact is expected to be material on the business.
• Evaluate the Range of Outcomes: Assess the amount, timing, and uncertainty of each of the various risks over the short-, medium-, and long-term.

STRATEGY AND RESILIENCE

Actuaries are integral to developing robust strategies and enhancing resilience against climate-related risks, ensuring that underwriting, reserves, financial projections, capital adequacy and investment strategies are all evaluated and where relevant, optimised.

• Underwriting and Pricing: Consider how changes in climate conditions and policies may affect claims frequency, severity, business mix, product structures, and reinsurance strategies. Furthermore, also consider the opportunities that the business expects to leverage and action in the short-, medium- and long-term.
• Reserving: Evaluate how climate-related risks might impact the calculation of best estimate reserves and risk adjustments, including the increasing uncertainty around the frequency and severity of claims in calculating the actuarial reserves – and considerations in the forward looking assumptions in setting the reserves for the unexpired risk under AASB17 and APRA’s prudential requirements (e.g. GPS340 and HPS340).
• Financial Projections and Cashflow Analysis: Develop long-term financial projections that incorporate the potential impact of climate-related risks and opportunities on claims, expenses, reinsurance, business mix, premium revenue and investment returns to inform business decisions.Management action that could capitalise on the opportunities that climate risk affords should be considered in the financial forecasting and cashflow analysis.
• Capital Adequacy: Review the Internal Capital Adequacy Assessment Process and risk appetite via scenario and sensitivity testing under different climate scenarios, regulatory changes, and varying reinsurance coverages.
• Investment Strategies: Assist in the review and assessment of the insurer’s exposure to climate risks within the investment portfolio to align with any climate risk management strategies and goals including asset-liability matching considerations.
• Discount Rates: Review and potentially adjust discount rates used in valuations, considering the impact of climate-related risks on future economic conditions over medium and long-term time horizon.

Within the actuarial function, shorter contract boundaries and typical 3-5 year business planning horizons necessitate additional effort to consider pricing and reserving assumptions for the medium to long term including the uncertainty surrounding them.

RISK MANAGEMENT

Actuaries are involved in insurer’s enterprise risk management activities, specifically around sourcing data, conducting sensitivity analyses, and prioritising climate-related risks to ensure comprehensive monitoring and robust mitigation strategies.  Some consideration around risk management are:

• Inputs and Parameters Used: Source data, specify the scope of analysis, and select key assumptions (e.g., future economic conditions and technological developments) that are expected to impact the business over medium to long term – taking into account impact areas as specified above.
• Scenario Analysis: Explain how the analysis is applied, highlight the most sensitive variables, and provide a range of outcomes for material risks.
• Nature, Likelihood, and Magnitude: Describe the nature of risks and outline the methodology used to assess the likelihood and magnitude of any climate change impacts.
• Prioritisation of Climate-Related Risks: Detail risk prioritisation criteria, compare these risks to other insurance risks, and implement a ranking approach.
• Monitoring: Provide an overview of the processes and tools used to monitor climate risks.

TIMING, REPORTING, AND COMPARATIVES

Additional reporting requirements from the actuarial function within the initial financial reporting cycle should be considered. The impact on BAU (business as usual) staff must also be evaluated until climate-related reporting becomes part of the standard BAU function.

Much of the actuarial input required for climate-related disclosures can be completed in advance of the peak year-end reporting cycle because a range of the required quantification and analysis pertain to aspects that can be managed outside the year-end financial results or position. Such analysis can also be embedded into established annual processes, such as business planning cycles.  This will this lead to some streamlining of actuarial work and processes, as well asl ensure that climate considerations are embedded into core business and strategic planning processes, which is a critical enabler to the effective management of climate risk.

METRICS AND TARGETS IDENTIFICATION

Actuaries are expected to collaborate with business units to identify key climate related metrics and targets, establish data collection processes, and ensure ongoing reporting.

• Identification: Identify metrics to quantify exposure to climate-related risks, financial impacts of climate events, and benefits from climate-related opportunities, covering claims losses, reinsurance, underwriting, investments, operational activities, and sustainable initiatives. Careful consideration should be given to how these metrics and targets will be integrated into regular business reporting, which business unit will be responsible, and at what level they will be reported.
• Target Setting and Monitoring: Establish targets for reducing emissions, mitigating climate-related risks, and developing innovative insurance products. Actuaries can support with monitoring progress to ensure alignment with industry best practices and regulatory requirements.
• Disclosure Governance: insurers, already managing physical climate risk, must disclose climate-related targets as per the standards. This could include traditional internal metrics (e.g. probable maximum loss, retention, combined operating ratio) if deemed climate related. Insurers need to consider carefully and document the approach, ensuring it passes through appropriate internal governance channels due to the sensitivity of such information and to mitigate the risk of sharing confidential information to the wider market.
• Compliance and Benchmarking: Ensure metrics and targets comply with ASRS and benchmark performance against industry standards and peers to identify improvement areas.
• Comparatives to International Standards (ISSB S2): ISSB S2 mandates specific disclosures related to probable maximum loss calculations across three probability/exceedance timeframes, by geography, gross and net of reinsurance, and by peril type. Whilst these are not mandated in Australia, insurers may consider adopting some of these metrics to maintain aligned and comparable to global peers reporting under ISSB S2. 

MEASUREMENT UNCERTAINTY (UNDERSTANDING AND COMMUNICATING)

With actuaries performing many of the cash flow projections and sensitivity testing, they will have in-depth knowledge around the data, key assumptions, and methodology used. Actuaries should work with finance and/or sustainability teams to get a clear understanding of the areas that require disclosure, develop a standardised way of capturing such information and support in the compilation of these disclosures. This includes communicating areas of high uncertainty, explaining the reasoning behind complex judgements, and outlining the range of potential results that may arise in future projections to help users of the information to understand uncertainties within the projections.

Authors : Kaise Stephan (Partner, Actuarial and Insurance Solutions), Jacquie Fegent-McGeachie (Partner, Climate & Sustainability), Ian Du Plessis (Senior Manager, Actuarial and Insurance Solutions), Justin Han (Senior Consultant, Actuarial and Insurance Solutions)