Emerging risks are potential threats that can have a significant impact on a company, an industry or the world. By their very nature, emerging risks involve a high degree of uncertainty since they are new, changing, or yet to be understood.
Anticipating risks is often a combination of perception, reality, vision and perspective. Recency can play a role, which is why rankings of current and future risks can look similar. Emerging risks also can be considered by likelihood (frequency), impact size (severity) and time horizons. Long-term risks from demographic changes, for example, do not share the immediacy of severe weather and the risk of natural catastrophes.
Identifying emerging risks is an inexact science, but actuaries, risk managers and decision makers must anticipate threats to assure resilience. Despite the multitude of emerging risk possibilities, there are those that rise to the top. There are also new developments. Surveys show that climate change is gaining importance as an emerging risk. This is an impressive change. Not long ago, the immediacy and long-term severity of climate change were not taken as seriously.
This article examines the top five risks chosen by participants from a list of 23 emerging risks for the “12th Annual Survey of Emerging Risks.” Released in February, the survey is sponsored by the Joint Risk Management Section — a collaboration of the Casualty Actuarial Society (CAS), Society of Actuaries (SOA) and Canadian Institute of Actuaries (CIA) — and conducted by Rudolph Financial Consulting, LLC.
To add perspective, the article includes the views of actuaries who specialize in enterprise risk management (ERM). The opinions of risk managers and other decision makers from around the world are also brought to bear from two other recently released surveys sponsored by the World Economic Forum (WEF) and Allianz Global Corporate & Specialty. In these additional surveys, risk is characterized differently, providing more specific risk concerns.
In the “Emerging Risks” survey, 267 primarily North American actuaries and risk managers most identified the five following emerging risks: climate change (22 percent); cyber/interconnectedness of (physical) infrastructure (15 percent); (disruptive) technology (13 percent); financial volatility (5 percent); and demographic shift (5 percent). Some of these risks also corrrelate, such as cyberrisk and disruptive technologies.
No. 1 Climate Change
For the first time, climate change ranks highest in the “Emerging Risks” survey, edging out cyber/interconnectedness of infrastructure (see Chart A). The highest number of respondents (22 percent) name climate change as their top emerging risk, up from 7 percent in last year’s report, where it tied with regional instability in the No. 5 slot.
In the past, climate change was understood as being far off in the future, explains S. Michael McLaughlin, a board member with OneAmerica Financial Partners who helped build the SOA’s Chartered Enterprise Risk Analyst (CERA) designation.
Chart A. Top Emerging Risks, 2018 Results
|6||Asset price collapse||5%|
|9||Interstate and civil wars||3%|
12th Annual Survey of Emerging Risks.
The physical damage from climate change, such as the impact of rising sea levels, McLaughlin notes, has fueled the issue’s immediacy. The Actuaries Climate Index® (ACI), which shows changes in extreme weather patterns, is also boosting awareness, he observes. The ACI, which became available in 2016, is sponsored by the American Academy of Actuaries, CAS, SOA and CIA.
There is a growing consensus that climate change is resulting in more frequent and severe natural catastrophes, observes Barry Franklin, regional head of risk for Zurich North America. “Whether you believe climate change is responsible for extreme weather events or not, natural catastrophes remain a significant risk,” he says. “There will be costs and risks associated with transitioning to a low-carbon economy,” he adds, and companies need to be prepared to deal with both.
According to the WEF’s “Global Risks Report 2019” (see Chart B), failure of climate change mitigation and adaptation is the second most likely risk. Extreme weather is ranked No. 1 in likelihood by the 1,000 risk managers, executives and leaders from around the world, and natural disasters are ranked No. 3. Released in January, the report was produced in partnership with Marsh & McLennan Companies and Zurich Insurance Group.
Chart B. Top 10 Risks by Likelihood
|1||Extreme weather events.|
|2||Failure of climate-change mitigation and adaptation.|
|4||Data fraud or theft.|
|6||Man-made environmental disasters.|
|7||Large-scale involuntary migration.|
|8||Biodiversity loss and ecosystem collapse.|
|10||Asset bubbles in a major economy.|
World Economic Forum “Global Risks Report 2019.”
No. 2 Cyber/Interconnectedness
Cyber/interconnectedness risk, aka cyberrisk, could arguably top the emerging risk list. While 15 percent of respondents in the “Emerging Risks” survey name it their top emerging risk, it still ranks No. 1 when respondents are asked to rank the one risk that has the greatest future strategic impact (see Chart C). Cyberrisk has reigned supreme in this spot since 2014, when it toppled economic volatility during the nervous years after the Great Recession.
Chart C. Top Five Emerging Risks with Greatest Future Impact, 2018 Results
12th Annual Survey of Emerging Risks.
Cyberrisk falls under a big umbrella; sources and other surveys cite several different types of cyber threats in their rankings. After the top three climate-related risks by likelihood, the WEF study ranks massive incidents of data fraud and theft as its fourth and cyberattacks as its fifth top risks.
In the Allianz Risk Barometer 2019, 340 Allianz Global Corporate & Specialty customers and insurance industry professionals ranked cyberrisk at No. 2 (see Chart D), as opposed to the WEF study’s No. 5 ranking of large-scale cyberattacks. The Allianz report indicates that the broad category of business interruption is the greatest risk for now and the next five years, with half of respondents seeing cyber incidents the most likely cause.
Cyberrisk is top of mind to Mario DiCaro, vice president of capital modeling & analytics at Tokio Marine HCC. “One of my main concerns is the contrast I hear between what some corporate security experts believe is possible and what is actually happening.” He explains that the issue seems to be a tendency to think the rules in place protect a system from failure when, in reality, rules are routinely broken or ignored. Those are specifically the weaknesses intruders try to exploit.
Chart D. Top 10 Risks in the U.S.A.
|1||Business interruption (incl. supply chain disruption)||40%||2 (39%)||↑|
|2||Cyber incidents (e.g., cybercrime, IT failure/outage, data breaches, fines and penalties)||36%||1 (45%)||↓|
|3||Natural catastrophes (e.g., storm, flood, earthquake)||33%||3 (38%)||=|
|4||Market developments (e.g., volatility, intensified competition/new entrants, M&A, market stagnation, market fluctuation)||27%||4 (23%)||=|
|5||Changes in legislation and regulation (e.g., trade wars and tariffs, economic sanctions, protectionism, Brexit, Euro-zone disintegration)||20%||6 (17%)||↑|
|6||Fire, explosion||18%||5 (19%)||↓|
|7||New technologies (e.g., impact of increasing interconnectivity, nanotechnology, artificial intelligence, 3D printing, autonomous vehicles, blockchain)||17%||8 (13%)||↑|
|8||Shortage of skilled workforce||14%||10 (11%)||↑|
|9||Climate change/increasing volatility of weather||12%||9 (11%)||=|
|9||Loss of reputation or brand value||12%||7 (14%)||↓|
Source: Allianz Global Corporate & Specialty.
Figures represent how often a risk was selected as a percentage of all responses for that country.
Respondents: 340. Responses: 405.
More than one risk and industry could be selected. Figures don’t add up to 100 percent as up to three risks could be selected.
No. 3 (Disruptive) Technology
Technology, or specifically the unintended consequences of technology, can lead to disruption, to catastrophic economic losses, or to both. Thirteen percent of respondents in the “Emerging Risks” survey consider disruptive technology — including drones, self-driving cars, additive manufacturing, the internet of things and nanoparticle exposure — their most imperative emerging risk.
Disruptive technology is a double-edged sword that can harm or help an organization. In the Allianz survey, 17 percent of U.S.-based respondents cite “new technologies” as a current and future risk, ranking it No. 7 on the list for the United States. It is also ranked No. 7 internationally based on the responses of 19 percent of the respondents in the Allianz Risk Barometer study. (See chart E.)
When asked to rank the new technology with the greatest risk potential, 67 percent of respondents in the Allianz survey name artificial intelligence, 43 percent autonomous vehicles/mobility and 27 percent block chain. When asked which new technologies are the most useful or valuable, 69 percent select artificial intelligence, 42 percent data science and 41 percent blockchain.*
Increasing reliance on technology, including cyber-connected devices, e-commerce and artificial intelligence, widens exposure for bad actors to threaten businesses with ransomware or business disruption, Franklin says. He also raises the issue of the insurance industry’s ability to keep pace with disruptive technologies and emerging business models from insurtech.
As the number of connected devices and machines increases, so do concerns about data security and protection, third-party liability and the aggregation of risks. “Internet of things technologies are generally not well-protected from cyberattacks as third parties can remotely control cars and possibly trucks in the future, among other intrusions,” observes Thomas Le, managing director of Ultimate Risk Solutions.
No. 4 Financial Volatility
Financial volatility relates to the ebb and flow of economic variables such as commodity prices, equity market performance and interest rates. Participants ranked this risk as No. 4 in the “Emerging Risks” survey. It ties with demographic shift at five percent of the top emerging risk vote.
“Demographics is destiny,” says Rudolph. “It’s tied in with other things, like low growth, due to an increase in the dependency ratio, and that is going to slow down the economy and growth.”
The Allianz report also ranks market development, which includes volatility, market stagnation and market fluctuation, as concern No. 4 for respondents from the United States. “Financial market condition risks, which include stock market volatility, changing interest rates, inflation and the effects of trade wars,” are all risks at the enterprise level, says McLaughlin. “When one industry suffers in a trade war, effects may be felt throughout the economy.” Le also points to the proliferation of exchange-traded funds (ETFs) and high-frequency trading “that could lead to wide financial market swings and contribute significantly to a financial market meltdown.”
The WEF’s report ranks asset bubbles 10th in likelihood. In this year’s “Emerging Risk” survey, asset price collapse ranked No. 6, slightly down from No. 5 in the previous study. Rudolph, author of the “Emerging Risks” study and principal of Rudolph Financial Consulting, points out that economic concerns tend to be considered current rather than emerging risks. In the long term, Rudolph also warns of an underappreciated risk. “We are at risk for low economic growth. The possibility of that is way higher than people realize.”
No. 5 Demographic Shift
Populations that are evolving by age, size and migration trends are driving changes in economic growth and levels of government intervention. “Demographics is destiny,” says Rudolph. “It’s tied in with other things, like low growth, due to an increase in the dependency ratio, and that is going to slow down the economy and growth.”
The ratio of the non-working, aged population (aged zero to 14 and over the age of 65) to those ages 15 to 64 years old is called the dependency ratio; this ratio is growing larger in the United States. “We are at a point where we have extended the federal balance sheet as far as we can, and we have to make choices,” Rudolph says. Like climate change, demographic change is an emerging risk requiring preparation. It could mean choosing between lowering social security payments and limiting college scholarships, he adds.
More immediately, companies have to closely monitor changes in customer groups and expectations and to fill talent gaps. Franklin sees a combination of concerns related to talent, including what he calls “generational brain drain” due to retiring seasoned workers being replaced by people who lack training and experience.
Chart E. Allianz Risk Barometer 2019 Top 10 Threats
Ranking changes are determined by positions year-on-year, ahead of percentages.
|1||Business interruption (incl. supply chain disruption)||37%||1 (42%)||=|
|2||Cyber incidents (e.g., cybercrime, IT failure/outage, data breaches, fines and penalties)1||37%||2 (40%)||=|
|3||Natural catastrophes (e.g., storm, flood, earthquake)||28%||3 (30%)||=|
|4||Changes in legislation and regulation (e.g., trade wars and tariffs, economic sanctions, protectionism, Brexit, Euro-zone disintegration)||27%||5 (21%)||↑|
|5||Market developments (e.g., volatility, intensified competition/new entrants, M&A, market stagnation, market fluctuations)||23%||4 (22%)||↓|
|6||Fire, explosion||19%||6 (20%)||=|
|7||New technologies (e.g., impact of increasing interconnectivity, nanotechnology, artificial intelligence, 3D printing, autonomous vehicles, blockchain)2||19%||7 (15%)||=|
|8||Climate change/increasing volatility of weather||13%||10 (10%)||↑|
|9||Loss of reputation or brand value3||13%||8 (13%)||↓|
|10||Shortage of skilled workforce||9%||15 (6%)||↑|
Source: Allianz Global Corporate & Specialty
The eighth annual Allianz Risk Barometer survey was conducted among Allianz customers (global businesses), brokers and industry trade organizations. It also surveyed risk consultants, underwriters, senior managers and claims experts in the corporate insurance segment of Allianz Global Corporate & Specialty and other Allianz entities. Figures represent the number of risks selected as a percentage of all survey responses (2,882) from 2,415 respondents. Applicable respondents could provide answers for up to two industries. All respondents could select up to three risks per industry. Figures don’t add up to 100 percent because three risks could be selected. Ranking changes are determined by positions year-on-year, instead of percentages.
Since the U.S. economy is currently doing well, companies are finding it difficult to recruit and retain employees, Franklin says, predicting the growing need for agility and flexibility in the workplace. The shortage of a skilled workforce is also a concern among respondents of the Allianz study, who rank it No. 8 for U.S. businesses and No. 10 worldwide.
While threats can vary considerably, certain emerging risks rise to the top. Climate change, regardless of the cause, can no longer be ignored. Cyberrisk also should remain high on the list for years to come. This is not just because of innovative bad actors, but because disrupting technologies and internet of things vulnerabilities will expand risk potential exponentially.
Unquestionably, there are other emerging risks, including pandemics and infectious diseases, regulatory changes, political distress (both on the worldwide and national stages) and terrorism. Having the courage to call out risks despite the lack of data — and encouraging resiliency — is what enterprise risk management is all about.
To those in the risk management profession, Rudolph offers caution. “The risk I worry about the most is that actuaries and risk managers aren’t looking far enough out into the future — our time horizon tends to be no longer than the tactical plan while it should preferably be as long as the liabilities,” he says.
*More than one risk and industry could be selected. Figures don’t add up to 100 percent as up to three risks could be selected.
1 Business interruption and cyber incidents are tied at the top of the ranking at 37%. However, business interruption received more responses by number.
2 Fire, explosion ranks higher than new technologies by number of responses.
3 Climate change/increasing volatility of weather ranks higher than loss of reputation or brand value by number of responses.
Annmarie Geddes Baribeau has been covering insurance and actuarial topics for nearly 30 years. Her blog can be found at www.insurancecommunicators.com.