The Climate Biennial Exploratory Scenario exercise (CBES) recently conducted by the Bank of England (BoE) shows that the UK’s largest insurers and reinsurers are getting better at managing financial risks caused by climate change, but analysts say there is still more to do.
Speaking at the Association of British Insurers (ABI) Climate Summit 2022, BoE executive Stefan Claus examined the results of the climate study, and how they will inform the regulatory approach to these risks going forward.
The objective of the CBES exercise was to examine climate-related financial risks that might unfold over a timescale of thirty years or more, considering two possible routes to net-zero carbon dioxide emissions globally by 2050 and one scenario in which governments fail to adequately address the challenge.
The idea was to examine the industry’s resilience to those risks, to see how the industry might respond to that evolution, and to consider the possible impact of this response to the wider economy, said Claus, who heads up the general insurance division at the BoE.
“This should provide insight for industry, regulators and government – by shining a spotlight on very long-term and otherwise opaque risks – to help decision-making and drive better risk management today,” he told attendees at the ABI conference.
Overall, the CBES were interpreted as showing that the largest insurers are making “good progress in some aspects of their climate risk management,” for instance in improving senior accountability and risk appetite.
“That said, there is still much more to do to understand the exposures to climate risks,” Claus added, highlighting in particular the lack of comprehensive and high quality data that continues to prevent effective climate risk management.
“Expertise in modelling climate-related risks is still relatively immature, and unsurprisingly, insurers’ results spanned a wide range,” the BoE exec stated. “This reflects the uncertainty, the sensitivity to assumptions as well as differing methodologies.”
Across all three CBES scenarios, BoE projections showed that if insurers do not respond effectively, climate risks are likely to cause a persistent and material drag on their profitability.
However, analysts also assured that overall costs to insurers from the transition to net-zero should be absorbable, partly because some losses are passed to policyholders through lower returns in savings and retirement products.
“Those costs will likely be much lower if early, well-ordered policy action is taken,” Claus said.
“This exercise has shown that the losses to both life and general insurers appear manageable under the three CBES scenarios. Their resilience means that they should be able to play their vital role in financing the transition to net zero, and driving improvements in resilience to physical risks,” he concluded.
“This will help reduce the (much bigger) risks to businesses and households, and will also bring opportunities in financing or insuring the new industries and infrastructure needed in an economy responding to climate change.”
“The PRA will continue to work closely with industry, and with our international partners, to help accelerate the development of these capabilities and our collective understanding of the risks and opportunities from climate change and the transition to net-zero.”
“At the same time, insurers will need to continue to develop more advanced capabilities to identify, measure and manage climate risks, including through incorporating climate risks in scenario analysis and investing in the development and scrutiny of models.”