Chicago — The potential impact of climate change is the greatest strategic risk currently facing the property/casualty insurance industry, according to a new study by New York-based Ernst & Young. For the life insurance industry, the study found demographic changes presenting the greatest strategic risk.

To compile the new study, Strategic business risk 2008, Ernst & Young and London-based Oxford Analytica Ltd. interviewed more than 70 industry analysts from around the world to identify the emerging trends and uncertainties driving the performance of the global insurance sector over the next five years. The study identified risks in three broad areas — macro, sector-specific and operational threats.

The top 10 risks are:

1. Climate change: long-term, far-reaching and with significant impact on the industry.

2. Demographic shifts in core markets: offers business opportunities but also risk on which other sectors will first capitalize.

3. Catastrophic events: rising costs and serious impact on earnings for insurers.

4. Emerging markets: risk and opportunity but also competitive threat from new players.

5. Regulatory intervention: increased scrutiny impacting on operations and practices.

6. Channel distribution: technology is changing the way insurance is sold and purchased.

7. Integration of technology with operations and strategy: an enabler to keep pace with competition, but lack of integration is a threat at the strategic business level.

8. Securities markets: changes in capital providers as well as the way capital is entering the insurance industry are causing major changes.

9. Legal risk: significant and unexpected change in the legal environment, such as government legislation or evolving case law, will continue to have a critical impact on the insurance industry.

10. Geopolitical or macroeconomic shocks: the likely causes are unknown but the consequences are potentially severe.

Ernst & Young also identified five emerging risks that have the potential to emerge over the next five years. These risks are: over reliance on model-based risk management, threats to industry reputation, losing the war for talent, increasing exposure to global regulatory heterogeneity and the possible emergence of entirely new risks.

These findings are an almost a direct inversion of a recent survey of 318 underwriters by Lloyd’s of London, which looked at their concerns for the coming year and found that the most worrisome storms were financial ones. While more than half of the respondents acknowledged that more needed to be done concerning climate change, only 39% said climate change is likely to contribute to above average losses from 2008 hurricane season.

Instead, their immediate concerns centered on instability in world financial markets and insurers’ ability to manage the insurance cycle. Climate change also trailed risks such as changing global dynamics, growth of corporate liability and terrorism/political risk among the concerns for Lloyd’s underwriters.

Yet the order of risks is somewhat beside the point. “Strategic risks vary for individual companies, but for the insurance sector as a whole, these are the threats the experts say will have the greatest and most far-reaching consequences,” notes Peter Porrino, global director of insurance services at Ernst & Young. “As the insurance environment becomes more complex, companies need to shift from traditional risk management approaches to integrated processes that add greater value.”

The study also notes that many of these risks are interlinked, with the consequences from one risk having direct impact on others. This was certainly the case for Zurich Financial Services Group, which needed to nsider the risks posed by climate change, an emerging market and an unstable political situation when providing political risk insurance for a hydroelectric power plant in Sri Lanka.

Zurich is providing political risk coverage to the U.S. sponsor of the five-megawatt hydropower plant on the Weli River in south central Sri Lanka. The hydropower plant will help the island nation address a growing need for electricity, and fits with Zurich's recently launched climate initiative, which is focused on providing solutions for risks associated with climate change.

“Zurich is committed to working with companies in emerging markets to address the risks associated with alternative energy projects,” says Daniel Riordan, EVP and managing director for Zurich’s emerging markets unit. “Political risk coverage is particularly important to private investors working with foreign governments to address the growing demand for efficient power sources."

Lindene Patton, SVP and counsel for Zurich NA, told Insurance Networking News that the company has historically used sophisticated tools to model and assess risk but in the energy sector, where the variables are changing rapidly, technology is particularly crucial. "We are looking to apply IT and other types of engineering technology to our core business, which is underwriting and risk management."

Sources: Ernst & Young, Zurich, INN archives

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