UK climate stress test a sign of increasing scrutiny of insurer climate risk

The Bank of England’s climate stress test is a sign that central banks and international regulators are looking to “ramp up” oversight of insurer climate risk, according to Guy Carpenter’s managing director of catastrophe advisory Jessica Turner.

In the latest interview in The Insurer TV’s Close Quarter series, Turner said the Bank of England’s Climate Biennial Exploratory Scenario (CBES) – launched this month – is indicative of a changing attitude among regulators to the assessment of the sustainability challenges facing insurers, including climate change.

“The Bank of England’s activities really ramped up under Mark Carney, the previous governor of the bank, who placed particular importance on climate change,” Turner said.

“The CBES is just the latest development in a long line of activity by the bank.”

The CBES exercise – announced in November last year – is designed to test the resilience of the largest banks and insurers against transition and physical risks associated with different potential climate scenarios, and the financial sector’s exposure more broadly to climate-related risk.

It builds on the Bank of England’s 2019 Insurance Stress Test and places six UK general insurers – including Aviva, Allianz, Axa, Direct Line and RSA – and 10 Lloyd’s managing agents under the microscope.

“It’s a challenging exercise,” Turner explained. “The ambition and the scope have expanded relative to the 2019 General Insurance Stress Test. [The bank] is looking at both the asset and the liability side of the balance sheet so that means that they’re stressing both transition risks and physical risks from climate change.”

Turner explained that the UK regulator is looking to assess the magnitude of risk that climate change poses to UK insurers and lenders, what impact it may have on business models and how change in access to insurance may – particularly around residential properties – impact banks’ credit risk.

It is also looking at ways it can better “encourage” insurers to embed climate change into risk management processes, she said, although these will not lead to any new capital requirements for firms – at least not yet.

“Solvency requirements are still geared towards the short-term outlook, but of course regulators are continuing to think about climate change, so that is potentially on the horizon,” Turner added, noting that the European Insurance and Occupational Pensions Authority is now consulting on whether changes to capital levels are required in the face of a changing climate.

Growing regulatory focus on ESG

Turner noted that the French regulator – Autorité de contrôle prudentiel et de résolution – has already completed a stress test exercise similar to the CBES for both banks and insurers which concluded that firms need to accelerate their preparedness and their quantification of climate change.

The US is also seeing a spike in activity with the Securities and Exchange Commission and the New York State insurance regulator calling on insurers to disclose the long-term impact of climate change on their operations.

“Increasingly shareholders are demanding for there to be climate change risk disclosures”

Turner predicted that scrutiny will continue to “ramp up” under the Biden administration, adding that insurers face pressure not only from national regulators but also increasingly from ratings agencies and shareholders.

“Increasingly shareholders are demanding for there to be climate change risk disclosures,” she said, pointing to growing awareness across the sector of the requirements listed under the Task Force on Climate-related Financial Disclosure.

“It’s currently voluntary, but there are a number of governments talking about putting this into law,” Turner continued.

The executive noted that greenhouse gas emissions only decreased by 7 percent in 2020 despite international lockdowns during the Covid-19 pandemic, highlighting the magnitude of the climate threat.

“Those insurers that respond well will have a good reputation that’s going to attract clients and is going to attract talent”

But Turner was bullish on the opportunities for (re)insurers and intermediaries offered by the climate change challenge.

“The firms that get this right are going to have better risk management than their competitors, they’re going to be better prepared,” she said. “There’s also a reputation element. Those insurers that respond well will have a good reputation that’s going to attract clients and is going to attract talent.”