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Paving the path to decarbonisation

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Open-access content Friday 22nd April 2022
Authors
Praveen Gupta
web_sunset-and-steel-factory_credit_iStock-645834110.jpg

My last piece was about the influence of climate change on insurance regulations in the US and the role of the Federal Insurance Office (FIO). The FIO in turn sought guidance from the Actuarial Association of America (AAA). However, before I come to that – there are two other developments that deserve due attention. 

Like the FIO, there is something even lesser known – the Office of Management and Budget (OMB). OMB’s most prominent function is to produce the president’s budget. It is important to understand a specific task assigned to it. And, of course, by now we have all heard a lot about the Intergovernmental Panel on Climate Change (IPCC) and its code red for humanity. Let’s, therefore, also see what the International Actuarial Association (IAA) has been up to in context of the IPCC. The latter first.

International Actuarial Association 

The IPCC Working Group addresses the most up-to-date physical understanding of the climate system and climate change. As Climate Science: A Summary for Actuaries describes: “It brings together the latest advances in climate science, combining multiple lines of evidence from paleoclimate, observations, process understanding, and global and regional climate simulations to get the clearest picture of past, present, and possible future climate.” 

Actuaries, it emphasises, as risk professionals need to understand the physical impacts of climate systems and climate changes. Such impacts will affect how risks are underwritten, priced, managed, and reported, whether for general, life or health insurance, pensions, other financial institutions, or social security. It is important for actuaries to understand the magnitude of the potential changes, the uncertainty of their frequency and intensity, and the inherent volatility of such risks.

Each of the physical changes analysed in the latest IPCC Working Group I report could have an impact on human well-being and the long-term sustainability of the environment. Within these changes, actuaries are particularly interested in the effect of climate change on floods, droughts, fires, storms, rise of sea level, air pollution and the long-term effects of climate change. 

The IAA has been doing some exceptional work by disseminating climate related implications for decarbonisation, flood risk, vulnerable populations, water resources, pension fund, ESG, climate related scenarios, IPCC reports and findings.

Office of Management and Budget 

For the first time in history, OMB has formally commenced accounting in the Federal budget for risks of climate change. Climate change threatens communities and sectors across the country, including through floods, drought, extreme heat, wildfires, and hurricanes that affect the U.S. economy and the lives of everyday Americans. 

The Federal Government plays a critical role in helping American families, businesses, and communities recover from the impacts of extreme weather events – often acting as an insurer of last resort. Growing damages from extreme weather events would add new pressures on the Federal budget and taxpayers. However, better modeling of the broader economic impacts of climate change can help to quantify economic and fiscal impacts of climate change and climate action.

To better understand and address these risks to taxpayers and the Federal budget, last May, the President directed the OMB to develop and publish annually an assessment of its climate-related fiscal risk exposure, as well as develop new methodologies to quantify climate risk within the Federal government’s economic assumptions.

The Ukraine invasion has suddenly driven the US to drill for more oil and gas. Thereby, furiously gnawing into the global carbon budget. The resulting greenhouse gases are bound to precipitate nasty climate outcomes, thereby affecting the insured, uninsured and uninsurable. With climate losses now touching US$120bn per year and expected to grow if greenhouse gas emissions continue unabated. The burden of economic losses increasingly comes on the federal government. Not accounting for them would be a recipe for a bigger disaster.

Federal Insurance Office / Actuarial Association of America 

One would like to seriously believe that the current situation is a short-term knee-jerk reaction. And that the federal government remains steadfast about sticking to a decarbonisation pathway aligned to the Paris Agreement. Its queries to the AAA broadly lie in the realm of both procedural and substantive. Hopefully, the responses received will only strengthen its resolve to remain in the driving seat.

It would be helpful, suggests the AAA, if FIO would consider a refinement of its goals to focus them, so that various stakeholders are able to understand and respond to FIO’s priorities. In addition, the goals should point towards measurable items such that progress can be articulated, providing a baseline and movement. 

Insurance supervision and regulation: Likewise, to include monitoring the integration of climate-related financial risks into insurance supervisory practices and regulatory frameworks, as well as assessing whether sufficient data, methodologies, and tools exist to manage the solvency of insurers and to protect them against the long-term risk of climate change.

Insurance markets and mitigation/resilience: AAA also suggests emphasis on the affordability and availability of insurance, particularly for consumers in traditionally underserved populations as well as mitigation strategies to improve resilience. The words “green investment” may be part of this focus as well. 

Insurance Sector Engagement: Last but not  least, the FIO plans to increase its engagement on climate-related issues and take a leadership role in analyzing how the insurance sector may help mitigate climate-related risks. FIO, therefore, will engage with the insurance sector to assess how the sector may help achieve national climate-related goals, including mitigation, adaptation, and transition to a lower carbon economy.

Some other observations and actionables sought from the AAA: 

The data to assess the insurance sector’s exposure to climate-related financial risks for short-term horizons may be more asset-based for life insurers and more geographic and directly climatic-based for health and property/casualty insurers.

The key factors for the insurance sector in developing standardised, comparable, and consistent climate-related financial risk disclosures - beginning with a comparison of the current National Association of Insurance Commissioners (NAIC) Climate Risk Disclosure Survey with the guidelines of the Task Force on Climate-related Financial Disclosures (TCFD), and the Carbon Disclosure Project (CDP) survey.

Is there a way forward to identifying and assessing climate-related issues or gaps in the supervision and regulation of insurers, including their potential impact on financial stability? It is a very broad question, believes the AAA. To truly answer it would require delving into the work that FIO may end up taking upon itself to define its role in context of: Prudential concerns; Market conduct; Consumer protection; Interdependence of insurance and other industries.

And what about identifying the key structural issues that could inhibit the ability of insurance supervisors to assess and manage climate-related financial risk in the insurance sector? The advice is that rather than classifying these as major barriers, consider them as challenges to the supervisors.

Evaluating approaches used by other jurisdictions or multi-national organisations that would help inform it about existing supervisory and regulatory issues and gaps concerning climate-related financial risks? The European Union asks all listed companies with more than 500 employees to complete an assessment consistent with the TCFD guidelines annually. The Prudential Regulatory Authority (PRA) in the UK has promulgated a framework. 

The time horizon for viewing disruptions to the availability and affordability of insurance coverage is a determining factor. Property insurers are most vulnerable in the short term to climate change impact related to currently measured elements of climatic conditions. “Additional impacts on longer-term horizons will affect other insurance coverages such as health, liability, and life.”

Many property insurers use catastrophe models within the underwriting process in part to determine issues related to concentration of risk combined with determination of the catastrophe portion of the premium. These models are also used by reinsurers for the underwriting of contracts as well as in determining the reinsurance price including rate and attachment. These uses cover a short-term time horizon and do not build in longer-term impacts of climate change. 

Conclusion

Not all the questions elicit a response nor do all those that were answered bear a mention here. The intent of the executive is certainly driving the regulators and the regulations in the desired direction. That how should FIO assess the availability and affordability of insurance coverage in U.S. markets that are particularly vulnerable to climate change impacts is a growing concern.

PGHow should FIO assess the efforts of insurers, through their underwriting activities, investment holdings, and business operations to meet the US’ climate goals, including reaching net-zero emissions by 2050? And what role or actions might states take to encourage the insurance sector's transition to a low emissions environment and an adaptive and resilient economy? These two compressed and critical questions draw a blank. Needless to mention, that the top US insurers remain highly entangled with the fossil fuel industry. Now how soon will fossil fuel compulsions, with time running out, tip in favour of renewables – remains to be seen. 

Praveen Gupta FCII is a Chartered insurer, former MD and CEO.

Image credit | iStock
 
Also filed in:
Opinion
Topics:
Climate Change
International
Regulation

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