Regulators raise the stakes on climate change - June Seminar 2019

David Worsfold

The insurance industry has been dragged centre stage in responding to the challenge of climate change.

The significant losses of recent years have hit global insurers and the Lloyd’s market very hard and have required a re-assessment of risks, increases in premiums and investment in claims handling capabilities. Regulators are making it clear that a rigorous response is essential, not optional.

The Bank of England has been amongst a small group of global regulators leading the way in warning of the risks climate change pose to the financial services sector – and demanding a response. This pressure comes from the top and follows the open letter in April to global financial institutions signed by Mark Carney, Governor of the Bank of England, Francois Villeroy de Galhau, Governor of the Banque de France, and Frank Elderson, Chair of the Network for Greening the Financial System (NGFS), which was a blunt wake-up call to the whole financial services sector.

In the UK, there has been a barrage of policy statements, reports and consultations. The Prudential Regulation Authority (PRA) has used these to urge insurers to identify and manage financial risks relating to climate change, the most recent towards the end of May (A framework for assessing financial impacts of physical climate change: A practitioner’s aide for the general insurance sector). The PRA expects insurers to have plans for how best to approach climate change within their current policies, especially meeting massive claims from the growing number of severe natural catastrophes. It wants the industry to look at how it can address the risks posed by this issue.

It also warned in a report published in April (Enhancing banks’ and insurers’ approaches to managing the financial risks for climate change. Supervisory statement SS3/19) that insurance companies could face a significant downgrade on their investments in fossil fuel companies if governmental pressure accelerates the move away from fossil fuels.

The latest report focusses on the general insurance sector and it sets out a practical framework that can be used to assess financial impacts from physical climate change risk for general insurance firms.

“Assessing financial risks from climate change is not trivial given the inherent uncertainty of long-term climatic model predictions, the lack of data, and the limitations of existing tools. We know from our supervision of general insurers that they are well placed to contribute towards this assessment by drawing on their expertise in modelling extreme weather risk. Harnessing this expertise can unlock the shift from awareness to action”, said David Rule
Executive Director of Insurance Supervision, PRA, on launching the report.

It accepts that the quantification of the impact of physical climate change on insurance liabilities is currently in the early stages of development but points to various studies investigating the impact of climate change on natural disasters. The report includes some case studies of its own assessing the impact of some recent natural catastrophes on insurers.

It also argues for a larger role for accessible tools to allow the assessment and contextualisation of these risks.

“To date, catastrophe models have used historical data to develop stochastic event sets. When considering the impact of climate change, where the future may differ from the past, changes to historical data should be accounted for. The catastrophe analytics industry is well placed to develop stochastic event sets to reflect future climatic states, such as using output from global climate models which better take into consideration the forward-looking impact of climate change … These tools could then be made available within existing catastrophe models to allow users to easily investigate climate change impacts on particular insurance portfolios”, says the report.

• These challenges will feature at the forthcoming Insurance Investment Exchange seminar on 18 June when the concluding panel session will address “Integrating Climate Risk and ESG into insurance portfolios” with Mark Cornelius, Head of the Major Life Groups Division at the PRA, joining the panel.

The keynote speaker will be Santosh Pandit, Senior Manager, Bank of England who will talk about “Internal ratings and the insurance portfolio: Philosophy and practical considerations”.