Regulator clarifies how insurers must address climate change risks
A Prudential Regulation Authority (PRA) working group has pulled together ways for the general insurance profession in the UK to get to grips with the impact of climate change increasing risk in the coming decades.
In an 85-page report, aimed at practitioners working with or at general insurance firms, the group outlines a framework for practitioners to use to assess financial impacts to the liability side of the firm's balance sheet caused by future climate change.
The framework, contained in the report titled, A framework for assessing financial impacts of physical climate change: A practitioner's aide for the General Insurance Sector, aims to be a starting point for firms to assess the impacts in the context of their business decisions and disclosure requirements.
The framework has six stages:
1) Identify business decision(s).
A physical climate change study would typically aim to inform a business decision or activity. This stage of the framework will decide the time horizon and metrics that need to be considered.
2) Define materiality.
This stage enables the firm to focus on the business areas where the physical risk from climate change could have a material impact on business decisions.
3) Conduct background research.
The firm will need to review existing scientific publications to understand better how climate change could influence the relevant areas identified. The likely outcome is a range of projected changes in frequencies or intensities for specific perils.
4) Assess available tools.
A decision will need to be made on which catastrophe tool(s) will provide the most suitable analysis.
5) Calculate impact.
This stage involves using the tools selected to assess the financial impact from the projected changes to the perils in question. Key considerations could include the appropriate communication of both the output and the uncertainty in the results.
6) Reporting and action.
Output from the use of the framework needs to be communicated to decision makers in a manner that can inform the business decision(s) in question, highlighting the limitations and uncertainty related to the analysis.
The report, which was published in May, also sets out recommendations for how the catastrophe analytics industry can contribute further, suggesting that it can play an important role in interpreting existing scientific studies and, combined with existing tools, assess the financial impacts from physical climate change while making recommendations for improving both future research and catastrophe tools development.
David Rule, executive director of insurance supervision at the PRA, said: "Climate change, and society's response to it, presents financial risks to insurers. While these risks will crystallise in full in the coming decades, they are already becoming apparent.
"The PRA expects insurers to take a strategic approach to addressing the risks from climate change, and from my recent discussions, many insurers are keen to make progress in developing a strategic approach.
He continued: "I encourage firms and practitioners to read this report alongside the PRA's supervisory statement 3/19 that sets out expectations for how banks and insurers should approach the financial risks from climate change, including that the response is led by the board, that it is embedded within existing financial risk management practice, that it uses (long-term) scenario analysis to inform strategy setting and risk assessment, and that it includes disclosure."
To read the report, visit: bankofengland.co.uk
Emma Ann Hughes is communications director of the CII