Regulator: catastrophe insurers should 'centralise' climate research

Out-Law Legal Update | 04 Jul 2019 | 3:18 pm | 3 min. read

Experienced catastrophe risk insurers should centralise useful information and research on climate for GI firms, a UK financial regulator has said. Climate models using historical data only should also be updated to incorporate future climate states. This will enable better investigation of climate change impacts on insurance portfolios.

  • Regulator publishes framework specifically aimed at catastrophe GI practitioners
  • General insurers would benefit from expertise when assessing portfolio impact
  • Pooling of research and adaptation of existing climate tools is needed

The Prudential Regulation Authority (PRA) has been keen for insurers to take a strategic approach to addressing the risks from climate change and last month published a report and framework for assessing the financial impact of physical climate change – the potential for changes in climate to affect extreme weather events and their impacts on the natural physical environment. The report has been prepared by a cross-industry working group including specialists from the PRA, Lloyd's, UK insurers and global reinsurers.

Aimed at GI practitioners in the field of climate and natural catastrophe assessment, it is especially for those assessing financial impacts to the liability side of balance sheets caused by future climate change. The framework is intended as a starting point for firms to assess impacts on business decisions and disclosure requirements. Although uncertainty and complexity is a given, the regulator believes there is significant expertise within the industry already to manage this.

The report notes that GI firms in the UK have developed significant expertise over the last three decades on assessing risk from weather-related natural catastrophes. Adapting this work to reflect the changing climate situation is however in its infancy.

The report emphasises that current climate models will have to be developed to incorporate future climate states. Those insurers experienced in catastrophe risk modelling can add value by centralising useful information and research and then providing this data to GI firms which can generate and apply credible assumptions, and by adapting models that currently only use historical data and making these available to allow users easily investigate climate change impacts on particular insurance portfolios.

A challenge for the industry is taking complex and unpredictable factors into account in projecting estimates. Projection methods will inevitably carry varying levels of sophistication. For example, projecting future greenhouse gas concentrations requires assumptions about political decisions that will impact those concentrations. The report is seeking to establish a cross-collaborative effort within the insurance industry to combine expertise and tackle these types of complex problems.

A number of case study scenarios have usefully been included to illustrate a more practical application. The scenarios purposely contradict each other to illustrate that firms might take different views on the materiality of perils depending on their exposure and business need.

The practical framework outlined in the report is intended to assist GI firms to assess the financial impacts from physical climate change risk. The six stages are:

  • Identify business decision(s): This stage is about deciding the time horizon and metrics that need to be considered around the affected business decision or activity.
  • Define materiality: This stage is about focusing on the business areas where the physical risk from climate change could have a material impact. 
  • Conduct background research: The firm will need to review existing scientific publications to understand better how climate change could influence the relevant areas identified. 
  • Assess available tools: A decision will need to be made on which catastrophe tool(s) 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 decision(s) in question, highlighting the limitations and uncertainty related to the analysis.

At the Green Finance Summit in London on Tuesday, an event which also coincided with the launch of the UK government's Green Finance Strategy policy paper, PRA Green Policy Advisor Lauren Anderson said that the regulator was working hard behind the scenes developing various scenario analysis with the aim of establishing a tool for firms to better understand the risk that they are holding. She emphasised that climate-related risk needed to be embedded in firms' general risk management, and said that "regulatory pace should not hold the industry back" in terms of continuing to take positive action. The issue is clearly at the top of the government and regulatory agenda.  

The framework is open for consultation until 22 November.