30 June 2021
The Bank of England has just published details of the 2021 Biennial Exploratory Scenario: Financial risks from climate change. Below I set out an overview of what the scenarios are and what insurers should be doing about them.
What is CBES?
Every two years the Bank of England puts out a Biennial Exploratory Scenario (BES). For each exercise there is a different focus for the scenario considered that is not covered as part of the annual solvency tests.
For 2021, the focus is Climate Change (hence Climate Biennial Exploratory Scenario or CBES). Through CBES, the Bank of England is going to assess the impact of climate-related risks on the UK financial system.
Only a selection of firms are required to complete CBES: 7 banks, 5 life insurers, 6 general insurers and 10 Lloyd’s syndicates are taking part in the scenarios exercise.
What are the scenarios?
Recently, the Bank published the pathways that firms will be considering as part of the scenarios. These pathways represent possible future scenarios over a 30-year time horizon, depending on the actions of governments, companies and individuals.
The pathways are:
- Early action is taken against climate change;
- late action is taken, ie we do nothing until 2031; and
- no action is taken at all.
In the first two scenarios, the temperature rise at the end of the scenario is assumed to be 1.8°C relative to pre-industrial levels, compared to 3.3°C in the third scenario.
I was pleased to see the additional detail and data provided for each of these pathways. It looks at what might change in the coming decades, eg the phasing out of fossil fuels or increased flooding in the UK, and how big the change might be under each pathway – although I was not pleased to read that if we do nothing the average winter precipitation in the UK could increase by 25%!
The scenarios will apply these pathways to today’s balance sheet ie not allowing for changes which firms may make to respond to climate change. Considering the impact on the current balance sheet highlights more clearly to the board what action they need to start taking now.
CBES feels a big step up from the 2019 PRA climate stress tests and helps to re-enforce the emphasis on climate change we have seen from regulators over the last year.
What will it mean for general insurers?
Although only a handful of insurers are currently required to complete these scenarios, they could set the industry standard for what is expected of firms in the future. Therefore, it is worth considering the CBES pathways now as you are developing your firm’s approach to climate change.
Both the UK Government and the PRA have made it clear that they expect all firms to have “embedded their approaches to managing climate-related financial risks by the end of 2021”. This will require firms to consider different climate-related scenarios, including a scenario which looks at a 2⁰C or lower temperature increase on pre-industrial levels, when looking at the resilience of the business strategy to climate change risk.
The Bank has said that CBES for insurers will “focus on changes in Invested Assets (and Reinsurance Recoverables), and Insurance Liabilities (including accepted Reinsurance)”. So far, there has not been much focus on the liability side for insurers (“it’s only a one-year policy” often used as the justification), but I am pleased CBES isn’t taking that view and is making it a focus.
Have a look at CBES and reflect upon your own approach to climate change risk. Is there:
- any additional information or data to help support the analysis you are doing? and/or
- anything you might want to change (or build in the flexibility to do so) in your scenarios?
The approach, information and best practice on climate change is developing so quickly, it is hard to keep up (I know - I try) but it’s worth paying a bit more attention to this announcement as it will help you stay up to date with this evolving and important issue.
The Bank of England expects to publish results in May 2022.
Please get in touch if you would like to discuss climate change risk.