By Kareline Daguer, Director, PwC
This summer we have seen terrible wildfires from Greece to the Arctic Circle and heat waves around the world, from Japan to California via the UK. These types of extreme weather related events are powerful in demonstrating that climate change is not only real but it is starting to have an impact on our daily lives. The time to think of climate change as someone else’s problem is over. In the next few years we will see a much stronger wave of climate activism. But what does it have to do with insurance prudential regulation I hear you ask?
Insurers are confronted by climate related risks in two distinct ways:
The physical effects of climate change - these manifest in increased frequency and severity of extreme weather related events. The following numbers are revealing: on a global basis, weather related insured losses have increased from an annual average of $10bn in the 1980s to an annual average of approximately $45bn so far this decade. So, insurance might become more costly in the years ahead and the losses are likely to be much more difficult to predict.
Transition risks - in the next few years we will see the global economy transition to a low carbon future and a future that is likely to be affected by changes in climate. Current investment strategies and asset types that look safe today might not be safe in 40 years’ time. This is demonstrated by significant valuation shifts in companies that are more directly affected by transitioning to a greener economy (from coal producers to utilities that have not adapted to policies on renewable energy). To mitigate this risk, investors are likely to shift to ‘green’ types of investments as a safeguard to the volatility created by climate change and transition.
So, what can we expect from insurers and regulators?
Up until now climate change risks were considered by firms as a corporate responsibility issue to be talked about, but without much tangible action needed. As the risks become clearer, it is becoming increasingly apparent that climate change poses a real financial risk for insurers that requires measuring and managing. The work developed by the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) over the last couple of years is very positive. Consistent disclosures on how climate related risks affect the financial position of firms should help investors make decisions and create the incentives needed for firms to demonstrate how they are tackling these risks effectively. The introduction of scenario analysis is a significant step forward in this area, where firms are expected to test how their strategies would fare under a few different scenarios of global warming.
It is clear that climate related risks will, at some point, impact the financial position and resilience of firms. The PRA is monitoring the situation but has not yet announced any specific requirements for firms to quantify and disclose their climate change risk exposures, risk management and strategies. For now the PRA has praised the TCFD endeavours but, since these disclosures are voluntary, it remains to be seen when the regulator will push for a more strict approach. I believe that climate change has been climbing slowly but steadily in the list of regulators’ concerns and firms should reflect this. We can all go on enjoying the current heat wave but insurers would benefit by being proactive in thinking through their climate change strategies and how to communicate with key stakeholders on the matter.
This is a new frontier for most of us in the insurance industry and, to get it right, we need a wide range of expertise, from mathematicians, modellers, climate scientists to business people. Firms need to start on this journey now as there is no opting out of the impact that climate change will have on the economy and each one of us in the years to come.
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