Heat and Emerging Risks – A Threat Multiplier for Actuarial Assumptions

written August 2024 by Max Rudolph

Temperatures during the recent el Nino climate pattern have set records for warmth. It will not be surprising if, similar to the years following a similar event in 1997, there is a pullback on temperatures. There is something about an el Nino event that causes the earth’s atmospheric temperature, or at the least the measurement of it, to spike. Over the next several years the comparison should be to periods like 1998-2000 rather than 2023. Rising temperature trends are no less inevitable than without the temporary spike given today’s greenhouse emissions.

I have been the sole researcher for the first 17 iterations of the emerging risk survey[1], and one of the primary takeaways for me has been the importance of risk combinations. The US Department of Defense coined the term threat multiplier specifically for climate change to show how interactions worsen existing threats. The term can also be appropriate for other risks, including wars, financial volatility and cyber.

When thinking specifically about increased heat and the implications for actuarial assumptions, it can be helpful to think in terms of the 23 risks considered in the survey and how they interact with a warming ecosystem. The risks are split into five categories: economic, environmental, geopolitical, societal and technological risks.

Economic risk category

Energy prices can be impacted in both directions from rising temperatures. Oil demand should eventually reduce as countries and individuals seek out greener alternatives, reducing energy demand for fossil fuels and reducing price. These businesses are cash cow investments, with limited growth opportunities and high incentives to lobby governments. Higher temperatures are hard on the physical structures used to get all types of energy from the source to its final destination, for example through pipe expansion or sparks from wires that cause wildfires, destroying infrastructure and releasing carbon. These will be common issues in a functioning economy, raising costs and slowing economic growth.

Emergent nations become less stable as the world warms, with economies and ecosystems stressed. Climate migration is already happening, whether between countries or to safer places within the same jurisdiction. This reduces political resiliency and increases fragility.

Asset prices, financial volatility and currencies all become more uncertain in this environment, reducing intrinsic values and expected returns.

Environmental risk category

This is where climate change itself is found, but weather related natural catastrophes like hurricanes and other severe storms depend in large part on heat. One situation to watch will be the melting ice near Greenland changing the salt density of the ocean in that area, slowing ocean currents. This would materially reduce temperatures in some regions, especially Europe, and increase them near the equator where there is already a question of livability as wet bulb temperatures rise. Other warming concerns that could lead to feedback loops include destroying Amazon rain forests and desert expansion.

Fresh water is key to human survival, but is also the source for much of the energy in mountainous areas through hydro power. A loss of glaciers sped up by the albedo effect, less snow pack to smooth the release of precipitation from mountain areas for agriculture, and heavier rainfall due to a warmer atmosphere holding more water all increase mortality and morbidity, but also economic assumptions and physical risks often covered by insurance.

Earthquakes occurring during a heatwave become much more stressful for the elderly, sick and socio-economically challenged communities.

Higher temperatures increase the moisture held in the atmosphere and the volume of water in oceans and lakes. This imperils islands and coastal areas due to sea level rise. It also makes convective storms of all kinds more likely and/or more severe. This will continue to get worse. But the primary direct heat impact from natural disasters is from heatwaves, drought, wildfire, wind and dust storms. Regular recurrences of persistent heat increase uncertainty, change expectations and economic pricing assumptions as it becomes more expensive to remain in an area, incenting people to leave. Insurers have repriced and pulled out of markets where the business environment is not sustainable.

Unknown knowns, where historical data is not predictive, is the new reality. Actuaries must revisit rules of thumb used for assumptions and either confirm their validity or work from first principles to build new projection models.

Geopolitical risk category

Terrorism, weapons of mass destruction, failing states, regional instability and wars are not only impacted by heat but also contribute to it. For example, during a war greenhouse gases face no restrictions. There is little focus on anything that slows the war effort. This could leave the Earth beyond a global tipping point, releasing the carbon currently held in permafrost and creating a feedback loop that quickly adds another three degrees Celsius to global average temperatures and destroying the private insurance market. Even lesser scenarios displace people into a demanding environment when their migration options are limited. We have seen that in many places, including Syria, Gaza and various locations in Africa, often triggered by bloodshed but with complications from heat the primary underlying factor.

Globalization increases when it is perceived as adding value for all sides. Once a group feels trade and other interactions are no longer beneficial, the process reverses and becomes self-fulfilling. This increases uncertainty, raises the discount rate and lowers potential returns. The resulting less efficient global economy lowers GDP and has fewer resources to help those in need of a safety net or infrastructure.

In a world with fewer legitimate connections, transnational crime and corruption encounters fewer impediments. Black markets for both legal and illegal goods stay below the radar. Financial products like pension plans and insurance are less likely to be purchased due to the uncertainty involved and a focus on actions necessary to survive. In an extreme scenario the Mad Max films present a good comparison to convey the tone.

Societal risk category

Melting permafrost has already released ancient infectious diseases. Vector borne diseases will also expand to new regions as winter freezes don’t inhibit the spread of mosquitos and ticks, and spillover diseases will expand due to concentrated industrial agriculture and humans living in close proximity to other species. Chronic diseases may be more or less treatable in a hotter environment. Deteriorating economic conditions due to heat make it more likely that these ailments would not be treated at all. A warmer planet widens the discrepancy between the economic and health experiences of the haves and the have nots, with implications to actuarial assumptions and likely reversion to higher fertility rates as child mortality rates increase.

A hotter environment increases litigiousness as there would be a search to blame others. This increases the cost of insurance and other everyday activities. Regulators will also follow the political will of the times and increase rules on those who remain as long as society remains intact.

Technological risk category

A warmer world makes individuals a little less attentive to their tasks, potentially lessening the quality of education and increasing the ability for cyber criminals to access personal and commercial accounts. Infrastructure such as roads are susceptible to heat and droughts, impacting economic growth and creating a feedback loop as infrastructure is not maintained.

Converting fully to green sources of power will be a challenge. Existing conversions of power plants, cars and household appliances, along with power demand from disruptive technologies like artificial intelligence, data centers and digital currencies that use a lot of electricity will make it extremely difficult to scale up using only hydro, wind and solar to move completely off fossil fuels. We’ll need to be more creative, for example using sodium instead of lithium to store energy in batteries in situations where weight doesn’t matter.

Conclusion

Heat works as a threat multiplier with other emerging risks, slowing the economy, increasing damage to infrastructure and making governments fragile. Resilience will increasingly be a problem around the world as a slower economy creates a feedback loop that generates less money to pay for upgrades, replacements and safety nets. The bottom of the socio-economic ladder is especially at risk. While liability assumptions are, not surprisingly, impacted, the changes on the asset side will require diligence from actuaries to understand. Assets built in at-risk areas will be worth less and discount rates will be higher due to greater uncertainty. Opportunity costs and defaults will increase. Much like pandemics, the risk may be greatest for those who recognize the risk, price for it, and don’t survive to the event since others wrote the business more cheaply having not identified the threats appropriately and eventually are forced to seek a bailout. Regulatory and professional organizations can encourage appropriate pricing and projection models to build sustainability in the market.

[1] The 17th Annual Survey of Emerging Risks can be found at https://www.soa.org/resources/research-reports/2024/17th-survey-emerging-risks/ . The glossary includes a list of the 23 risks discussed and their definition.