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Insurance regulators expected to ramp up climate risk scrutiny

Following a public consultation the International Association of Insurance Supervisors (IAIS) has recently released its final Issues Paper on Climate Change Risks to the Insurance Sector. Its conclusions could push regulators to scrutinise climate risk more closely.

The Paper aims to provide an overview of how climate change is affecting and may affect the insurance industry, and how this is relevant to insurance regulators.

According to the IAIS, climate risks present significant material challenges for the insurance sector which are likely to grow over time. While some of these risks are long-term in nature, others are already having material impacts today.

In particular, the Paper explores how physical, transition and liability risks are relevant to insurers across both their underwriting and investment activities. Notably, the stranded asset risks associated with investing in coal and other fossil fuels are raised and civil society activism is highlighted as a reputational risk to firms if not properly managed.

The IAIS states that efforts to mitigate these climate risks are likely to require:

  • Coherent governance: Climate risks to be addressed at relevant levels within an insurer, including at board level, through appropriate governance, strategic, and operational frameworks and policies;
  • Mainstreaming: Integrating climate risks across the mainstream risk management functions and internal controls of an insurer, including for example the strengthening of technical risk assessment capacities (ie catastrophe models) to integrate climate change factors;
  • Integrated approaches: Considering climate risks across lines of insurance businesses and operations, including across underwriting and investment activities, to leverage insights from both sides of the business, and create a holistic strategy considering both assets and liabilities;
  • Skill-building: Building the skills and capabilities of practitioners with respect to climate risk issues, to ensure that they are able to utilise relevant climate-related risk information in their everyday activities;
  • Educating consumers: Taking steps to educate their customers about climate risks, raise awareness of options to help mitigate risks and build resilience, and increase transparency on the significance of climate risks in risk-based pricing;
  • Monitoring: Introducing measurement systems to ensure that efforts listed above are being effectively implemented across business functions, and achieving stated objectives.

As well as considering what actions insurers may take to manage climate risks, the Paper discusses the approach of insurance regulators. The IAIS recognises that climate change is relevant to microprudential solvency, consumer protection, and macroprudential stability. Ultimately, they conclude that there is an urgent imperative to consider the resilience of insurers to climate risk.

As part of their analysis, the IAIS produced case studies on how a selection of regulators are approaching climate risks. For example, the Paper discusses the Climate Risk Carbon Initiative launched by the California Department of Insurance.

This initiative required Californian insurers to disclose their investments in fossil fuels through a data call. On analysing the data it was found that Californian insurers may be heavily exposed to the stranded asset risks associated with coal as their portfolios were consistent with a trajectory of six degrees of global warming. In order for investments to be aligned with a scenario of two degrees of warming, there is a significant need for coal-fired power capacity retirements.

Scenario analyses are a useful tool for considering transition risks, and other supervisors may adopt this approach in the future. The IAIS recognises that such tools may also assist in analysing physical risk trends and underwriting strategies.

Ultimately, the Paper provides information that will assist supervisors in considering how to assess and respond to climate risk. Platforms such as the SIF and IAIS provide a framework through which supervisors can learn from experience in other jurisdictions – a process which may fast-track the level of supervisory sophistication in managing climate risk.

Insurers with coherent systems to evaluate and manage climate risk will be ahead of the curve when supervisory scrutiny of climate risk inevitably intensifies. For those who lag behind, the Paper provides a warning sign of changing regulatory attitudes which they would do well to heed.

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