Flood risk and the modern actuary: Climate change reshapes insurance

As our world and its climate change rapidly, it’s never been more important for the financial industry to confidently understand and assess climate-related physical risk. 

Actuaries in particular are increasingly seeking both a better understanding of climate- and flood-related risk, and more representative, robust ways to measure and manage uncertainty.

The modern actuary and the role of data science

The actuarial profession is evolving, and fast. 

Actuaries are rapidly moving away from historical mathematical models in favor of data science. Traditionally, actuaries have relied on historical claims data and mathematical models to assess risk. Historical data is important – but the modern actuarial role builds on this with forward-looking techniques which are resilient to change and, in turn, produce more robust risk models. Such models assess not only historical claims data but also contain a significant amount of supplementary external information and use modern techniques (for example data science, machine learning, climate and flood model output) enabling actuaries to adapt to evolving risk, price more accurately, and manage present-day and future risk proactively.

Climate research shows that…

• The footprint of urban areas in floodplains has doubled globally in just 30 years
• We can expect significant increases in extreme rainfall as our warming climate intensifies the hydrological cycle
• Flood hazard and impact are projected to increase for many parts of the globe due to river flooding, with future hotspots anticipated in Asia and Africa
• The annual cost of flooding will increase over the next century in the UK by up to 23% above recent historic levels
• Flood-related insurance losses have almost doubled in the last 10 years
• In the past decade, a minority of severe flood losses have been insured: just 5% in emerging markets and 34% in advanced economies

As our climate changes rapidly, it’s crucial to understand the risk posed by flooding both now and under a whole range of unprecedented possible future conditions. 

At present, flood risk is often managed under the assumption that history is a good predictor of the future – but this is no longer the case. 

The very nature of flooding is changing, with floods becoming more frequent, severe, and occurring in places that have not seen significant flooding before. This change is driven by both urbanization and climate change, meaning that it is impossible to rely purely on historical data to assess current and future risk – we are in a non-stationary system.

Our entire perception of risk stands to be impacted by our changing climate system. Meaning that past observations of rainfall patterns, river flows and sea levels no longer reflect those experienced today: we are in a non-stationary system. Climate change will impact everything from human health and mortality to financial stability and asset value, affecting underwriting, pricing and reporting across sectors from general insurance to pensions. More tangibly, it will bring changes to floods, droughts, wildfires and other instances of extreme weather at varying levels of frequency, severity, magnitude and volatility, threatening the long-term wellbeing of human society and our environment. 

Climate-focused actuarial roles are on the rise, with organizations recognizing the importance of calculating climate risk and impact in the actuarial space. To fully comprehend the risk landscape of the future, actuaries must understand how our changing climate will bring physical impacts that affect the regulatory and market landscape and result in potential financial losses.