The results of the 2021 Climate Biennial Exploratory Scenario (CBES) were published by the Bank of England (BoE) on 24 May 2022. What information can we glean from these results?
The report covered an exercise carried out by large insurance companies and banks exploring the potential impacts of three climate change scenarios – “early transition, late transition and no additional action.”
The BoE has promised individual feedback to firms who participated as part of their SS3/19 supervisory regime of management of climate risks. However, the report provides a number of pointers towards their thinking and the direction of regulation for the insurance industry. This blog sets these out.
1. The BoE still cares strongly about climate change risks and the potential impact on the stability of the financial system
Whilst the impacts calculated were not huge (and it is recognised that they probably overstate impacts due to the lack of management actions), especially compared to existing risks considered in Solvency II 1 in 200-year capital calculations, the BoE sees the impacts of transition to net zero as potentially weakening firms and making them more vulnerable to other risks. It is clear they intend to continue to expect improvements in climate change risk management.
2. Modelling capabilities are not yet thorough or flexible enough
In particular, the BoE recognises that the third party data needed to make detailed assessments (e.g. data on counterparties’ emissions and transition plans) are not currently available and work is needed to collect that information.
For assets, good practice is to have sector specific modelling with name specific modelling for large exposures. However, currently the assumptions on losses vary considerably between firms, with the BoE identifying 10x differences in asset price impacts for the same name.
The report states that life insurers rely heavily on third party models, which can often be inflexible. It says the key to good modelling is the ability to identify the limitations of models and make adjustments to address these.
Also, the BoE is keen that models can take into account changes in asset values due to changes in sentiment and expectations, not just differences in actual outcomes.
3. The BoE is concerned about damaging consequences of blanket policies
For example, if firms just apply blanket exclusions, firms looking to transition to important areas such as renewable energy may not get financing or insurance. This could be damaging to overall net zero ambitions and the economy.
The BoE did state that it appears that most life insurers are not applying a divestment strategy, preferring to engage with existing counterparties.
4. The potential inability of a large proportion of home owners to get insurance or funding
This was the most worrying impact for me. If risks such as flood risks rise, insurance premiums may rise to be unaffordable to many. Such properties will fall significantly in value and it will be impossible to get mortgages for them. As well as being an issue for homeowners, this is clearly an issue for those issuing equity release mortgages.
5. Whilst capital needs to reflect climate risks, it isn’t seen as the stick to make people undertake climate risk management
The BoE is planning a research conference in Q4 2022 looking at reflecting climate change in capital requirements. However, they make the point that capital regulations are not the best way to drive reductions in emissions. A number of life insurers made the point that being forced into “green” assets could force up the prices of those assets.
However, the BoE point to best practice being to include climate scenarios in the stress and scenario testing carried out for ORSAs.
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