European insurance regulators ramp up focus on climate change

Out-Law News | 14 Nov 2019 | 1:23 pm | 2 min. read

EU and UK regulators have emphasised that climate change risks, and how insurers approach and manage them, will be an increasing area of focus for them.

The European Insurance and Occupational Pensions Authority (EIOPA) will focus its regulatory efforts in the coming years on climate-related risks, as well as risks associated with cyber crime, big data and digital technology, its chair Gabriel Bernadino said last week, in an address to the European Parliament's economic and monetary affairs committee (ECON) (4-page / 272KB PDF).

The UK's Prudential Regulation Authority (PRA) has written to insurers (5-page / 153KB PDF) warning them against using outdated models to calculate their exposure to climate change risks. The regulator is concerned extreme weather events and other climate change-related phenomena "may be changing in their nature, frequency or severity" and may give rise to greater losses than insurers have currently accounted for.

Sawers Iain

Iain Sawers

Partner

Regulators are challenging the insurance industry to ensure that risk modelling used to calculate the impact of climate change events accurately mirrors the actual pace of change.

Insurance law expert Iain Sawers of Pinsent Masons, the law firm behind Out-Law, said: "Climate change will continue to be a key challenge for the industry over the next few years".

"Whilst insurers and brokers are well aware of the potential threat climate change poses to market stability, it is clear that the number and scale of global extreme weather events, caused by climate change, are increasing. Unprecedented temperature rises and upwards revisions of the pace of global warming by climate scientists and meteorologists are frequently in the press," he said.

"Regulators are challenging the insurance industry to ensure that risk modelling used to calculate the impact of climate change events accurately mirrors the actual pace of change. We would expect the industry to welcome clear guidance from regulators on the prudent approach required to appropriately manage the risk that climate change poses to underwriting losses, whilst still ensuring that underwriters can remain competitive," he said.

In his ECON address, Bernadino said that EIOPA was concerned that the insurance industry was not properly keeping pace with the impact of "more frequent and severe" natural catastrophes. The 'protection gap', or value of uninsured risks, linked to these phenomena is growing, he said.

"The impact of this on households, businesses and the financial system cannot be underestimated," he said.

EIOPA is also expecting insurers to contribute to climate change adaptation and mitigation activities in a "stewardship role", through their investment and underwriting activities, Bernadino said.

In the UK, the PRA has been carrying out exposure management reviews at regulated firms following the publication of its April 2019 policy and supervisory statements on managing the financial risks associated with climate change. In his letter to firms Gareth Truan, the PRA's acting director of insurance supervision, said that the PRA had found "a number of areas for improvement" as a result of those reviews, particularly around the use of outdated and inappropriate risk modelling.

"Such firms may experience losses which are much larger than expected if these model assumptions prove misplaced (e.g. through inadequate post-loss amplification or contingent business interruption allowance)," he said. "We encourage firms to consider back-testing actual and near-miss losses against modelled estimates, which can highlight firms' potential for model error when assessing current hazard and exposure trends."