Climate Change Risk – what now?

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Climate change has been in the news a lot lately. It has made an appearance in various publications from the Prudential Regulation Authority (PRA), Financial Conduct Authority (FCA) and European Insurance and Occupational Pensions Authority (EIOPA). Here at Barnett Waddingham, we’ve been giving it a lot of thought too!

The regulatory and political focus, both national and international, on the effects of climate change and the potential response to these effects, has intensified significantly over the previous few months. Recent publications from the PRA, FCA and EIOPA show us that regulators expect insurers to take action to improve their approach to managing risks from climate change. Though in consultation stages, new EIOPA guidelines are being drafted. This includes, but is not limited to, insurers explicitly disclosing climate change exposures.

What should insurers be doing to assess these risks, in order to ensure compliance and avoid negative publicity?

The issues for insurers go way beyond the obvious short-term physical risks, for both general and life insurers. Some examples of climate change impacts include:

 

These are first-order risks arising from more severe weather-related events. To manage these risks, insurers need sophisticated methods of modelling and assessing risk. It has been reported that in 2016 and 2017, scientists published at least 41 studies concluding that climate change has led to increased risk of extreme weather events around the world [1].
Exposure on professional indemnity or Directors and Officers (D&O) risks, for claims of negligence in assessing risks from, or not fully mitigating the impact on, climate change of their company. Claims could come from those who have suffered loss and damage as a result of climate change due to the company seeking to recover losses. These claims may be passed on to insurers.
Widespread disruption in the traditional energy sector and the corresponding rise of “Green Energy” could result in poor investment returns or periods of high volatility of returns for insurers. Indirect impacts will also be seen on other industrial sectors, such as Food and Retail, through the disruption of, for example, supply chains as more severe weather events occur more frequently.
Society is more socially conscious than ever before. As such, in order to attract and retain the investors of the future, corporate social responsibility programmes will become more important for insurers. 
We are already seeing an increased level of scrutiny on insurers’ approach to managing the risk posed by climate change. The FCA have dealt with a number of industry complaints involving insurers failing to disclose their exposure to climate change.
For life insurers specifically, how mortality (and morbidity) will be affected by a changing climate is uncertain. It is certain however, that there will be an impact. The specific impact is likely to vary by geographical location and other societal factors such as age.

There are a number of actions insurers can take now, including:

  • Formally setting out their approach to climate change-related risks in investment policy.
  • Use of scenario analysis to assess climate risks - this is currently one of the most practical tools available as a starting point to quantify risks (e.g. in own risk and solvency assessment (ORSA)).
  • Parameterise Internal Models to explicitly allow for climate change risks. For natural catastrophe estimation, this will require insurers to open a dialogue with third party vendors to understand the extent of allowances for climate change. Similarly, asset-side modelling in Economic Scenario Generators could also cater explicitly for such risks.
  • Consideration of how to isolate climate change from other risks, and what weight should be given relative to other major risks such as cyber, pandemics and artificial intelligence. For example, facilitating the explicit setting of reserves related to climate change.
  • Ensure annual disclosures are compliant with the Task Force on Climate-related Financial Disclosures recommendations.

What’s next?

The biggest challenge for insurers is taking these highly uncertain climate change risks and linking them back to what drives their insurance business. That’s where Barnett Waddingham can help.

 

1Energy & Climate Intelligence Unit

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