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

2025-08-22

AI Summary

Conventional dynamic financial analysis (DFA) frameworks neglect the long-term impacts of climate change, limiting their ability to comprehensively assess climate-related risks in the insurance sector. Method: This paper develops the first climate-dependent DFA framework, integrating physical climate risks and macroeconomic drivers. It employs stochastic simulation across multiple climate scenarios to model the co-evolution of assets and liabilities over time, quantifying how interactions between economic growth and disaster frequency shape risk-return profiles. The methodology synthesizes DFA, climate scenario analysis, actuarial modeling, and interdependent systems modeling, with empirical calibration using Australian data. Contribution/Results: Findings reveal pronounced divergence in insurer financial resilience across distinct temperature pathways. The framework delivers actionable, quantitative insights for prudential regulation, climate-informed stress testing, and low-carbon strategic planning—advancing both theoretical modeling and practical risk management in climate-vulnerable financial institutions.

Technology Category

• Reasoning under Uncertainty: Decision/Utility Theory
• Game Theory and Economic Paradigms: Applications
• Machine Learning: Calibration & Uncertainty Quantification

Application Category

• Graph Algorithms and Modeling for the Web: Efficient manipulation of static and dynamic Web-related graphs
• Economics, Online Markets and Human Computation: Incentives in network design for Web infrastructures and ecosystems
• Responsible Web: Sustainability and climate impact of web technologies

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 introduce a climate-dependent DFA approach that integrates climate risk into DFA, providing a holistic assessment of the long-term impact of climate change on the general insurance industry. The proposed framework has three key features. First, it 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. Second, it addresses the uncertainty of climate change impacts using stochastic simulations within climate scenario analysis that are useful for actuarial applications. Finally, the framework is tailored to the general insurance sector by addressing its unique characteristics. To demonstrate the practical application of our model, we conduct an extensive empirical study using Australian data to assess the long-term financial impact of climate change on the general insurance market under various climate scenarios. The results show that the interaction between economic growth and physical risk plays a key role in shaping general insurers' risk-return profiles. Limitations of our framework are thoroughly discussed.

Problem

• Integrates climate risk into Dynamic Financial Analysis for insurers
• Assesses long-term climate change impacts on insurer finances
• Addresses uncertainty using stochastic climate scenario simulations

Innovation

• Climate-dependent DFA integrating climate risk
• Stochastic simulations for climate scenario analysis
• Tailored framework for general insurance sector