Climate risk modeling for insurers

The insurance sector faces an unprecedented challenge in managing the risks associated with climate change. In 2024 alone, extreme weather events cost Canada $8.5 billion in insured damages – nearly three times the $3.1 billion recorded in 2023.¹ For every dollar covered by insurance, governments, businesses, and communities bear an additional $3–4 in uninsurable damages. This underscores the urgent need for property and casualty insurers to adopt comprehensive climate risk modeling within their risk management frameworks. While property damage often dominates headlines, life and health insurers must also address challenges from events like wildfires and heatwaves, which degrade air quality and exacerbate heat exposure. These conditions can have severe implications for vulnerable populations.

But what exactly is climate risk modeling? Climate risk modeling refers to a type of scenario analysis that offers a flexible "what if" framework. It allows stakeholders to explore a range of potential climate scenarios and understand the qualitative and quantitative impacts these scenarios may have. Insurers integrate the outputs of climate models into their core processes, such as underwriting, pricing, reserving, and capital management. By leveraging the insights provided by climate risk modeling, insurers can address uncertainties proactively, align their operational strategies with both immediate and long-term needs, and strengthen their resilience in an era of accelerating climate-related disruptions.

This article will explore the concept of climate risk modeling, its integration into the insurance industry, and how it supports sustainable growth while mitigating financial and operational risks.

The release of OSFI’s Guideline B-15 has elevated the importance of integrating climate-related financial disclosures and risk-return analyses in Canada’s insurance sector. This regulatory push is causing insurers to adopt early to gain a strategic edge. Yet, a significant portion of insurers continue to grapple with readiness challenges, reflecting the broader climate risk modeling struggles within the industry.

Life and health (L&H) insurers face specific difficulties, as climate scenario modeling remains an area of limited focus, particularly for small and medium players who are still in the early stages of building these capabilities. On the other hand, property and casualty (P&C) insurers, though relatively experienced in catastrophe modeling, are challenged with incorporating long-term climate projections into their frameworks. This gap hinders the sector’s ability to address the medium-to long-term impacts of climate change comprehensively, leaving a critical compliance void.

Internationally, regulatory bodies in Europe serve as a benchmark, imposing more tailored and specific requirements that ensure comprehensive climate risk integration for insurers. Canada has made notable strides under Guideline B-15, with OSFI laying a robust foundation for the country’s insurers to align with global practices. However, to enhance resilience in the face of accelerating climate risks, Canadian insurers need to collaborate effectively with the scientific community, industry bodies and regulators to support enhanced data availability and the investment in advanced modeling technologies.

Climate change introduces two broad types of risk for insurers, categorized as physical risks (e.g., storms, flooding, sea-level rise) and transitional risks (e.g., policy shifts, technology changes, evolving consumer preferences).

P&C insurers face acute physical risks, with short-term challenges stemming from frequent catastrophic events like wildfires and hurricanes. Such risks strain claims operations and reserves, demanding a shift from reactive measures like premium hikes towards long-term strategies, including the use of predictive tools that support the understanding of financial and operational impact of climate risks.

L&H insurers, on the other hand, contend with chronic risks like heat-induced mortality and morbidity which are exacerbated by data gaps, especially in North America. Addressing these gaps through localized studies would bolster insurers’ ability to refine their understanding of the mortality morbidity impacts that result from a changing climate.

Scenario analysis, built on climate projections from both Representative Concentration Pathways (RCPs) and Shared Socioeconomic Pathways (SSPs), facilitates an integrated understanding of physical and transition risks. The output from these climate projections supports the forecast of shifts in claims trends, asset valuation, and operational impacts, offering a method to anticipate challenges and adapt operational and strategic decisions proactively.

To navigate the escalating risks of climate change effectively, insurers would benefit from considering an adaptive and forward-looking approach that incorporates both physical and transition risks. By integrating scenario analysis in different use cases, and investing in research to bridge data gaps, insurers can position themselves to enhance resilience, ensure compliance, and contribute to the broader objective of climate risk management.

Effective climate risk modeling would take into consideration three key elements: assumptions, time horizon, and methodology. Effectiveness requires that climate scenario analysis is not just viewed as a compliance exercise but is integrated into risk management and business decision making.

• Key assumptions: Effective climate risk modeling starts with identifying plausible climate pathways and translating these scenarios into assumptions for modeling purposes, with a goal of measuring economic impacts. Insurers should consider the cascading implications of acute (e.g. extreme weather events) and chronic (e.g. rising temperatures) physical risks, as well as transition risks as identified under various climate pathways.
• Time horizon: A successful climate risk model is dynamic, evolving continuously through updated data and refined scenarios. It is imperative to align model outputs with regulatory mandates, such as Guideline B-15, to ensure that the results are relevant and impactful. Critical outputs include measurable milestones – adjustable markers that allow insurers to respond effectively to new data and regulatory changes – and tools to balance short-term liquidity needs with longer-term solvency and growth objectives. Insurers will need to consider different time horizons, each of which requires tailored approaches:

o   Short-term horizons (0–3 years): Critical for refining underwriting practices and pricing to reflect immediate risks

o   Medium-term horizons (4–8 years): Essential to support reserving decisions and risk-adjusted capital planning

o   Long-term horizons (10–20+ years): Influences long-range strategic planning and ensures alignment with capital return expectations

• Methodology: Climate scenario analysis is a rapidly evolving field. It is important for insurers to keep abreast of developments in data, tools and approaches. The objectives of scenario analysis and the entity’s modeling capability are key considerations in the choice of methodology. As an insurer develops experience with scenario modeling and improves the supporting data and tools, it is expected that the use cases and sophistication of the approach will increase
•  Leveraging modeling for strategic advantage: Insurers can use climate risk modeling as more than a compliance tool – it can foster innovation and competitive differentiation. Tailored strategies for different lines of insurance include:

o   For P&C insurers: Modeling helps design "build back better" initiatives post-catastrophes, reducing future claims costs by improving the resilience of insured properties

o   For L&H insurers: It offers insights into diversifying into green finance, positioning them as leaders in supporting sustainability while mitigating asset risks

By integrating these interconnected components, climate risk modeling evolves from being a regulatory necessity to becoming a cornerstone of forward-thinking, adaptive business strategies. This can help ensure both short-term resilience and long-term sustainability for insurers in a dynamic climate landscape.

While the core principles of climate risk modeling are consistent across the insurance industry, their practical implementations diverge based on the unique operational and financial imperatives of P&C insurers versus L&H insurers:

Property and casualty insurers

P&C insurers grapple primarily with acute physical risks, including natural catastrophes like hurricanes, floods, and wildfires. The focus is on immediate strategies that mitigate catastrophic claims and ensure financial stability. Key tactics include:

• Granular risk assessment: Using highly detailed geographical and structural data to manage exposure. For example, two homes in the same geocode may face different flood or fire risks depending on elevation and surrounding debris. This data granularity is critical for accurate risk modeling and pricing adjustments
• Resilient claim settlements: Innovative approaches such as incorporating climate-resilient materials when settling claims (e.g., rebuilding homes with durable structures) reduce the likelihood of repeat losses while promoting resilience against future disasters
• Collaboration and education: Working closely with government and policyholders to enhance preparedness, such as promoting preventive measures like debris clearance around properties to reduce fire hazards.

Life and health insurers

L&H insurers encounter indirect but pervasive risks tied to chronic effects from climate change, such as heat-induced mortality or morbidity. These risks lead to nuanced challenges in analyzing and managing long-term life and health products. Core strategies include:

• Localized data studies: Addressing current gaps in location-specific heatwave data for North America to refine morbidity and mortality projections
• Investment portfolio de-risking: Active diversification away from fossil-fuel-dependent industries reduces exposure to transition risks, such as market volatility arising from decarbonization policies. This aligns with broader global trends toward sustainability
• Leveraging green finance: Utilizing investment opportunities in renewable energy and sustainability projects (e.g., green bonds) to enhance balance sheet resilience while supporting climate adaptation programs, positioning insurers as leaders in green investment strategies.

By tailoring strategies to their specific industry contexts, both P&C and L&H insurers can blend risk mitigation with forward-looking ambitions – ultimately fostering resilience and creating pathways for operational and financial innovation.

Climate change is no longer just an environmental issue – it's a business imperative. While the challenges of climate risk are significant, they also present opportunities for innovation and growth. With a structured approach to modeling, insurers can align with regulatory requirements, improve operational resiliency and seize market opportunities. Insurers should use today’s uncertainty to design strategies that balance risk and opportunity in the long term.

Integrating climate risk modeling into an insurer’s business brings challenges, including securing stakeholder buy-in, managing quality climate and other data, and embedding this knowledge into decision-making processes. KPMG offers expertise to help guide insurers such as:

• Gap analysis: KPMG can help insurers conduct gap analyses to identify compliance shortcomings under evolving frameworks such as Guideline B-15. After completing this analysis, we collaborate with you to develop actionable roadmaps for bridging gaps effectively and efficiently
• Scenario modeling expertise: Utilizing climate modeling expertise, we assist in tailoring climate scenarios to insurer-specific models, aligning outputs with both regulatory requirements and long-term strategic goals
• A global network with local relevance: We can leverage KPMG’s global network of professionals to share knowledge and emerging practices with colleagues in countries leading the charge. This access helps ensure we bring cutting-edge solutions to local markets
• Strategic transformation: Beyond compliance, we can work with insurers to embed climate considerations, helping them use these frameworks to identify opportunities, like new products or competitive differentiation.