On 5 June 2019, the Treasury Committee launched an inquiry into the decarbonisation of the UK economy and green finance which will look at the role of the UK regulators and financial services firms in supporting the government’s climate change commitments. One of the areas under scrutiny is how financial services firms are delivering green finance or investing in ‘green assets’ and what prudential risks climate change poses. The Committee will also consider what steps the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) are taking to support decarbonisation and the ‘greening’ of the economy.
As far as the insurance industry is concerned, the UK regulators are ahead of the game – in 2015 the PRA published a report on the impact of climate change on the UK insurance sector and in 2018, the FCA published a discussion paper on climate change and green finance. More recently, in April 2019 the PRA published a policy statement and supervisory statement on enhancing banks’ and insurers’ approaches to managing financial risks from climate change. The PRA has set out its expectations of how it expects insurers to develop a strategic approach to managing these risks which includes:
- Embedding the consideration of financial risks from climate change into governance arrangements and financial risk management practice.
- Using (long term) scenario analysis to inform strategy setting, risk assessment and identification.
- Considering whether additional disclosures are necessary to improve transparency.
Last month, on 22 May 2019, the PRA published a report on a framework for assessing the financial impacts of physical climate change for general insurance. The report is the result of a collaboration of an industry-wide working group with members from the insurance and reinsurance industry. The framework is intended to be a starting point for insurers to develop their own assessment of financial impacts on an insurer’s liabilities caused by future climate change and how this may impact on business decisions.
The framework consists of six stages:
- Identify business decisions: This stage establishes the context for analysis and will determine the time horizon and metrics that need to be considered.
- 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.
- 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 conclusions should be used as a basis to assess loss impacts.
- Assess available tools: A decision will need to be made on which catastrophe tools will provide the most suitable analysis.
- Calculate impact: This stage involves using the tools selected to assess the financial impact from the projected changes to the perils in question.
- 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 decisions in question, highlighting the limitations and uncertainty related to the analysis.
The report also:
- Considers the tools that are currently available that can be used to assess physical climate change risk and explains when it may be appropriate to use each tool.
- Sets out case studies illustrating how the framework could operate in practice.
- Provides recommendations for the future development of tools and processes necessary to assess the financial impacts from climate change risk beyond property, physical climate change risk, and insurance.
The working group is seeking feedback on the framework by 22 November 2019.
The deadline for submissions to the Treasury Committee’s inquiry is 26 July 2019.