Dynamic Financial Analysis (DFA) of General Insurers under Climate Change

TL;DR

This paper extends traditional Dynamic Financial Analysis to incorporate climate change risks, providing a comprehensive framework for assessing long-term impacts on general insurers using empirical Australian data.

Contribution

It introduces a climate-aware DFA model tailored for the insurance sector, integrating physical and economic climate scenarios with stochastic simulations.

Findings

Climate-dependent DFA offers more accurate financial projections than stationary DFA.

Interaction between economic growth and physical risk significantly influences insurers' risk-return profiles.

Empirical analysis demonstrates the model's practical applicability using Australian data.

Abstract

Climate change is expected to significantly affect the physical, financial, and economic environments over the long term, posing risks to the financial health of general insurers. While general insurers typically use Dynamic Financial Analysis (DFA) for a comprehensive view of financial impacts, traditional DFA as presented in the literature does not consider the impact of climate change. To address this gap, we extend the stationary DFA framework to integrate climate risk, enabling a holistic assessment of the long-term impact of climate change on the general insurance industry and offering a foundational architecture for the DFA of individual insurers. Our framework captures the long-term impact of climate change on the assets and liabilities of general insurers by considering both physical and economic dimensions across different climate scenarios within an interconnected structure. Furthermore, it addresses the uncertainty of climate change impacts using stochastic simulations within climate scenario analysis that are useful for actuarial applications. Our extensions are tailored to the general insurance sector and address its unique characteristics. To demonstrate the practical application of our model, we conduct an extensive empirical study using Australian data and assess the long-term financial impact of climate change on the general insurance market under various climate scenarios. The results are benchmarked against those of a stationary DFA framework and show that the interaction between economic growth and physical risk plays a key role in shaping general insurers' risk-return profiles. They highlight the advantages of the climate-dependent DFA over the stationary DFA in generating financial projections under climate change impacts. Limitations of our framework are thoroughly discussed.