Regulators’ increasingly closer focus on climate change will spur insurers to protect themselves better, according to rating agency Moody’s, which has released a new analysis on the subject.
According to the analysis, ‘Global insurance regulators increase focus on climate risk’, climate change exposes insurers directly to physical risk, carbon transition risk and legal risk, while its potential to destabilise economies and financial markets is a source of additional indirect risk.
European supervisors are most advanced in their approach to climate risk, it suggested, adding that while this is credit positive for insurers, particularly in Europe, it also exposes them to greater risk of regulatory non-compliance.
“Increased disclosure of climate-related risks will help insurers measure, benchmark and manage their exposure to climate risks,” said Brandan Holmes, vice president and senior credit officer at Moody’s Investors Service. “It will also encourage them to consider climate risk and sustainability more rigorously in their investing and underwriting decisions, improving their overall risk management.”
Moody’s identifies five broad areas of developing regulatory focus on climate risk:
More rigorous disclosure requirements
“Insurers’ disclosure of their climate risk exposure makes a key contribution to regulators’ and investors’ understanding of how climate change affects the sector. However, accurately assessing the exposure embedded within insurers’ investment portfolios requires rigorous disclosure of climate risk metrics from all large publicly listed companies. The BoE has cited lack of data as an impediment to insurers’ efforts to understand and measure the physical and transition risks within their asset portfolios.
“As a result, governments are increasingly pushing for more comprehensive disclosure of climate-related risks, with financial regulators setting specific requirements for financial institutions, including insurers.
“In November 2020 the UK Treasury said it would make it mandatory for many UK companies to report their climate risk exposures in line with the standards of the Task Force on Climate- related Financial Disclosures (TCFD). We expect that the Securities and Exchange Commission in the US will adopt similar requirements under the Biden administration.”
Encouraging increased participation in sustainable finance
“Regulators worldwide are encouraging insurers to increase their involvement in sustainable finance. They have for the most part refrained from offering direct incentives to invest in this area, such as lower capital charges for sustainable assets. Instead, they rely mainly on disclosure and stress testing to incentivize greater insurer participation. However, direct incentives are planned in some APAC markets, and remain under discussion in Europe.
“We expect investor scrutiny to push insurers towards greater investment in sustainable finance as disclosure around climate risk becomes more widespread, and over time, mandatory. At the same time, stress test outcomes will incentivise insurers to withdraw from carbon intensive assets and move into sustainable alternatives.
“Increased focus on sustainable investing and underwriting is positive for insurers because it positions them to benefit from new market opportunities, while also reducing their exposure to sectors that might be negatively affected by carbon transition. However, many of the key areas of sustainable investing involve new or rapidly evolving technologies, such as renewable energy, which can carry higher investment and underwriting risk. As insurers increase their focus on sustainable finance, they will therefore need to continue balancing the potential upsides against risk.”
Improving understanding of insurers’ climate risk exposure
“Most regulators begin with exploratory exercises to understand insurers’ exposure to climate risks, and their potential financial impact. European regulators are currently most advanced in this area. At present, they achieve this primarily through private data gathering, although we expect enhanced public disclosure over time.”
Enhanced governance and more focused strategic response
“Regulators are focused on understanding insurers’ governance response to climate risks, and on how they are adapting their strategies, business models and risk management. Some regulators are communicating their expectations regarding companies’ governance and strategic responses.”
Stress testing to identify exposure and improve response.
“Regulators are scrutinising insurers’ climate-related stress testing and scenario analysis. They aim to identify data and capability gaps, and set out expectations for more sophisticated testing.”