Climate change regulations:
Where should I start?

There's growing recognition that climate change will affect the insurance sector, whether it be through impacts on meteorological perils and insurability, investment activities or achieving longer-term sustainable development goals. Already, businesses are accounting for climate change in their planning and longer-term decision-making and this has recently been supported by the UK's PRA. 

In April 2019, the PRA released a Supervisory Statement to encourage firms to enhance their approach to managing the financial risks from climate change. The following month, a framework for assessing physical climate change risk was issued as an aide for the general insurance sector. Then, on 18 June, the PRA released its biennial General Insurance Stress Test (GIST), designed to "make sure banks and insurance companies are strong enough to withstand another financial crisis". The GIST asks the largest regulated life and general insurers in the UK to provide information about the impact of a range of stress tests on their business (Bank of England, 2019). As well as the usual tests for different perils, such as flood, this GIST includes an exploratory exercise on climate change.

The PRA's documents aren't designed to catch businesses out; rather, their aim is to help firms better understand how to assess the potential impact of climate change on their business.

What are the PRA climate change documents?

1. Framework

The framework for assessing physical climate change risk, released in May, aims to be a practical guide to helping firms answer the question: "how could the decision/business processes be impacted given a range of possible climate outcomes?"

Figure 1: the 6-step framework developed by the PRA to help firms assess physical climate change risk. (Image © 2019 Bank of England)

It includes a range of case studies demonstrating how this framework can be applied to a business for a range of perils, and the potential tools available to firms to help answer this very question, including JBA's UK Flood Model and UK Climate Change Flood Model.

2. GIST

The GIST's climate change exploratory exercise is designed to capture information to help understand how firms are managing difficult-to-assess risks like climate change. Firms are requested to consider different climate change scenarios for different perils, split into quantitative data-driven scenario analysis (Part 1), and a qualitative information gathering section (Part 2).

Part 1 considers different perils and regions and is designed to encourage firms to consider the potential quantifiable impacts of climate change on their business. The PRA has identified three potential future scenarios it would like firms to consider:

• A: a 2°C warming by 2100, but with disorderly transition. It assumes the collapse of asset prices (Minsky Moment) by 2022.
• B: a 2°C warming by 2100, following an orderly transition (broadly in line with the Paris Agreement) by 2050.
• C: a ‘hot house’ scenario, reaching maximum warming of 5°C by 2100, in line with Representative Concentration Pathway (RCP) 8.5 (‘continue as normal’ scenario).

Part 2 could be considered a qualitative approach. It is relevant for those who have already made progress in developing climate change scenarios, and so the focus is on how these are being translated into more detailed assumptions to assess tangible financial impacts on a business. In essence, firms already assessing the potential impacts of climate change are encouraged to demonstrate to the PRA how these results are being put into practice.

Information overload?

With so much information now available, it's difficult to identify useful tools and services to answer some of the questions posed by the PRA.

The framework for assessing physical climate change risk is a great starting point as it offers a range of tools and case studies, including the use of catastrophe models and hazard maps for challenges around UK flood underwriting, pricing and risk selection by 2040.

However, it's important for businesses to go beyond a starting point and to gain a more in-depth view of the risk, which is where the GIST comes in. If we consider quantitative analysis, then firms could use a catastrophe model, such as JBA's UK Climate Change Flood Model, to better understand the potential impact of climate change on their portfolio.

For example, firms could consider:

• Portfolio-level analysis to obtain a future estimate of AAL and 100-year AEP (in-line with PRA recommendations)
• Single-event analysis, comparing between present-day and future risk
• An event footprint using present-day and future hazard data

As well as being able to offer all the above, JBA can provide additional guidance to firms on how to extrapolate these results to the required PRA time horizons (2050 and 2100).

On hand to help

Not only has JBA contributed to PRA’s recent framework and GIST, we are actively engaging with firms to help them follow the framework and/or address the requirements of the GIST. With our expertise in flood and growing investment in climate change research, we are involved in a number of international collaborations and initiatives related to climate change.

If you'd like to learn more about JBA's existing tools and expertise to help you understand the potential impacts of climate change on your business, please get in touch for more information.

References

Bank of England (2019). Stress testing. [online] Available at: https://www.bankofengland.co.uk/stress-testing [Accessed 26 June 2019]