To survive in the long term, Canadian insurance companies must focus on risks beyond the current global financial crisis. Even as the economic meltdown dominates headlines, new challenges loom on the horizon—and climate change is in the lead.

Insurance companies must strike a careful balance between short-term and long-term risks. Now is the time to learn as much as possible about the strategic threat that climate change and other risks pose, and create a plan of attack.

Climate tops the risk list
Last spring, climate change topped Ernst & Young’s 2008 strategic business risk report for insurance. From evolving regulatory requirements to the impending retirement of countless baby boomers, insurers already had a lot to think about. Still, climate change took first place as a major strategic—and immediate—concern. That’s because so many recent, far-reaching events have actually been manifestations of climate change. For example, natural catastrophes resulted in insured losses of over $50 billion (US) in 2008.

This year, this important issue will drop down on the risk list—only because of the tough financial environment. But global warming is changing our weather patterns, and that’s causing a fundamental shift in the underlying probability of insured loss (e.g., by windstorm, flooding, heat wave). Some regions of the world now experience weather that’s never been typical for their area—forcing insurers to scrutinize their insurability criteria for certain risks.

Impact of the climate change risk
What does this mean? Climate change and catastrophic events represent a long-term threat to the growth, profitability and efficiency of insurance companies and reinsurance firms, who will be hit the hardest when a major event occurs. Essentially, climate change has the power to affect everything from insurability criteria to company pricing structures and reserving policies, as well as solvency and corporate viability.

Besides the more obvious events like storms, flooding and wildfires, climate change can lead to broader, more gradual consequences that extend across geographies and insurance classes. For instance:

• Increased health problems and mortalities
• The spread of environment-related litigation
• Political risk linked to conflicts for control of resources
• Effects on capital classes

What you should do now
It’s time to start talking. Dramatic increases in losses from natural catastrophes linked to climate change mean policyholders and regulators need to discuss these issues now.

Your action plan should include these five critical elements:

1. Keep an open mind. Assess risks annually to define the threats you’re facing, weigh their probability and examine their impact on business drivers.
2. Go big and broad. Expand risk assessment beyond financial and regulatory risk to consider your organization’s wider environment, and the full extent of your operations.
3. Plan for anything. Plot out the major risks you face, and develop a number of operational responses for every scenario.
4. Grade yourself. Evaluate your organization’s ability to manage the identified risks and ask yourself how effective your processes are. Then fill the gaps.
5. Mine the data. You can learn a lot from the compliance activities you’re required to complete. Review the data you collect to identify earlier warnings and improve your ability to respond.

As the weather changes, so do the risks of natural disasters. The first step is opening up the lines of communication among stakeholders. Then it’s time to decide what will constitute a reasonable market price for insurance in those areas. But you can’t stop there.

Stakeholders will need to keep evaluating and rethinking these prices on a continuing basis. It’s important to start talking. The key will be in carrying these conversations forward, and keeping them going as the situation evolves.

Risk management is the key. The financial crisis has shown the world what happens when people don’t stay on top of risks. Companies must work risk management into their overall business strategy, and improve underwriting, if they’re going to succeed.

Companies that invest in their ability to comprehend climate change risk will improve their underwriting performance. You need to get the big picture on climate change—and the catastrophic events it generates—before you can manage the issue effectively. Only then will you be ready to work risk management into all aspects of your business.

The view from 30,000 feet
Climate change might not have made our risk list 15 years ago. In 2008, it surged to first place. This year, new risks will undoubtedly emerge. With the focus on financial markets increasing and much-needed investment dollars slowing, companies may not respond to climate change as quickly. However, it continues to be a mega-risk and a burden for the industry that can result in broader and more gradual consequences. Analysts expect leading insurance firms to more aggressively manage this risk and to project an image as responsible corporate citizens. The way companies deal with climate change and its impact may influence investment and financing availability in the future. Market shares could even change as companies withdraw or contract in traditional geographies and products, and enter new ones.

Your ability to succeed will depend on how closely you examine what’s coming, and how well you plan for the possible outcomes. You need to address climate change as one strategic element of the longer term plan (like product development and resource planning). This issue must stay high on the risk agenda. The best way to manage risks is to tackle them now, before the aftermath lands on your doorstep.

Tom Kornya, partner, Canadian Insurance, Ernst & Young LLP.