An Evolving Emerging Risk

Many of us thought 2021 would bring a respite from the incredibly disruptive year that was 2020. As if to mock us—with recurring regularity—each Wednesday in January 2021 marked events that will be recorded in an unforgettable chapter in our history books.

• Jan 6. Washington, D.C., suffers from what is described as an insurrection, as so-called patriots occupy the U.S. Capitol.
• Jan 13. The House of Representatives impeaches President Donald Trump for the second time.
• Jan 20. Joe Biden is sworn in as the 46^th president of the United States.
• Jan 27. Finance chat rooms coordinate trades opposite Wall Street short sellers, squeezing their positions and creating volatility throughout the system.

Emerging Risks

The risks involved in many of these events are considered emerging. They represent events that have not happened before or represent evolving risks. In the 14^th annual Survey of Emerging Risks,¹ risk managers shared their rankings of current risks, top five emerging risks, top emerging risk and risk combinations.

Not surprisingly, the pandemics/infectious diseases risk was the top current risk, with 45 percent choosing it after a previous high of 8 percent following the Ebola epidemic in 2014. COVID-19 is top-of-mind for everyone right now, and it interacts with many of the other risks in the survey.

Results for the top five emerging risks across the four most recent surveys are shown in Figure 1. Many of the same risks regularly top the rankings.

Following an event-filled year, reasonable expectations for 2021 might have included short-term COVID-19 concerns, such as dealing with the fallout from issues like mental health and food insecurity as vaccines are rolled out.

For many years, climate change has been the elephant in the room. Even when acknowledged, many think of it as a risk for future generations to deal with. People don’t understand that small changes in temperature lead to increased volatility in extreme weather events. Temperatures have already risen by 1°C due to fossil fuel use, and that use is accelerating. In addition, the buildup of carbon dioxide and other greenhouse gases is cumulative, with some lasting in the atmosphere for up to 1,000 years.

Since 2018, the annual Survey of Emerging Risks has reflected the growing importance of climate change to risk managers, but the incentive to act has lagged behind other important risk management activities. But there are signs that this is changing.

As Figure 2 shows, interest in climate change has grown during recent surveys. Even though results are down in 2020 due to the surge in pandemic responses, respondents continue to choose climate change as the top emerging risk (26 percent), and it dominates the category (second place is disruptive technology with 15 percent).

But is this growth in interest fast enough? Climate change, through feedback loops, creates tipping points with results that were not priced for. Unknown knowns, where historical data is available but not predictive, have repercussions if not addressed. Claims from recent California wildfires were larger than the premiums collected over the decades of exposure. The warming atmosphere and oceans are impacting ice cover. In the Arctic Ocean, ice is retreating, which in turn affects the jet stream and weather patterns across the northern hemisphere. As ice on Greenland melts, freshwater release is expected to impact the salinity that drives the Gulf Stream. The role of clouds is particularly challenging in a warming atmosphere, with some models anticipating that they will cease to form as temperatures rise.

If climate change continues unabated, there will be major human migratory challenges. Wide swaths around the equator will be too hot to support large populations, and other areas will be subject to sea level rise that overwhelms flood defenses. Some areas will resemble a Mad Max movie, and other locations where previously there had been vibrant communities will be reclaimed by the ocean.

Risk is opportunity! The Society of Actuaries (SOA) tagline encourages two-sided risk analysis. While much of climate change will lead to negative consequences, there are some positives. Some crops will thrive closer to the poles, and areas in northern Canada and Siberia will be sustainable to development and form civilization hubs.

Role for Actuaries

Actuaries analyze the financial consequences of risk. We are not doctors, but we price the financial impact of health insurance, pensions and life insurance. We are not seismologists, but we price homeowners’ insurance in earthquake zones. The best actuaries have at least a working knowledge of economic theory and investment practices.

Climate change impacts traditional practice areas, often in unintended and surprising ways. Actuaries can act as interpreters between scientists and those with financial interests, testing the implications of various scenarios and seeking out data to ensure feasibility of solutions for all groups.

One way to learn about current practices in dealing with climate change is to monitor what other professionals are doing. The Task Force on Climate-related Financial Disclosures (TCFD)² is built around peer pressure rather than regulation, and it is designed to encourage organizations to provide a standard set of information to groups like insurance underwriters and investors. Reading how other organizations are managing climate risks will help actuaries analyze assets and liabilities and encourage them to extend their time horizon to consider all types of emerging risks.

When dealing with risks, we are incented to focus on those occurring sooner rather than later. While some respondents to the emerging risks survey reported they were positively recognized for their proactive pandemic scenarios, most had minimal or no preparation for the coronavirus event. Luckily, for some risks, the work-from-home option is an important component of business continuity plans, so many organizations had some practices in place. Essential workers, especially those in service industries, were not as lucky. As schools shut down, women reduced their labor force participation rate to take care of their families. Socioeconomic status is often the overriding factor during risk events due to past discriminatory policies.

One type of risk interaction that climate change could easily create is a low economic growth scenario that leads to low interest rates, especially given the point at which we find ourselves today. Climate change has three components that slow growth:

1. Repairing or eliminating the past buildup of greenhouse gases
2. Rebuilding existing infrastructure damaged by natural disasters
3. Building infrastructure to adapt or mitigate the effects of climate change in the future

Low nominal rates lead to a lack of incentive to build infrastructure, creating a feedback loop. Low growth means choices need to be made. Money is not free, and safety nets will compete against spending on defense or education. Actuaries have the skill set to make these calculations and participate in the decision-making process to improve future outcomes.

Conclusion

Risk managers scan continuously for emerging risks, but those expected to appear in the immediate or tactical time horizons take precedence over long-term risks and opportunities. It’s important for both organizations and individuals to spend time regularly thinking about strategic planning and how they want their exposures to develop over time. The impact of climate change is as important as—and may even dominate—economic risks over longer time horizons. Those who recognize and manage the climate risk will be more prepared for whatever scenarios are thrown their way.

Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries or the respective authors’ employers.

Copyright © 2021 by the Society of Actuaries, Chicago, Illinois.