Has climate change
risk been downgraded by the PRA?
8 March 2023
Following all the climate change talks at GIRO in November 2022, we were hopeful that it would become a focus for insurers in 2023.
However, the recent Dear CEO letter published by the PRA has financial risks arising from climate change under 'Other areas of focus' while it was an explicit priority in 2022. We think this will come back in 2024 as a top priority so if you are looking to get ahead, here is how you can build climate change considerations into three of the PRA’s top explicit priorities for 2023: risk management, inflation, and operational risk and resilience.
The PRA says that firms should 'assess the adequacy of their risk management' and 'be able to respond to market and credit risk conditions different from those that prevailed for a long time.' A key factor driving market conditions in the future will be how we respond to climate change - a smooth or disorderly climate transition are predicted to have very different impacts on the market.
Climate modelling considers different future pathways and models how economic conditions might vary in these situations. You could use this modelling to help you assess what risks your company might face in these future circumstances eg possible stranded assets or volatile economic markets. This can help inform strategic decisions now.
For actuaries, a big challenge with inflation has been dealing with the fact that the past is not at all a good guide to the future, which is also one of the key challenges when it comes to quantifying climate change risk. When you are adjusting for a different future inflation environment, you should also think 'should we be adjusting for a different climate?'
As global temperatures continue to rise, the likelihood, severity and locations of cat events will change. This may happen more slowly over time than the recent shock to inflation, but you can still use this opportunity to make allowances not just for changes to future inflation but for climate change as well.
For example, some insurers discovered their inflation volatility assumptions did not allow for the shock we saw in 2022, so consider reviewing your cat volatility assumptions against climate scientists' predictions to ensure your models adequately capture future possible events. You could also consider an ORSA stress test which is a cat event in an area that's normally low risk or sensitivity test the parameters in the catastrophe model as part of model validation.
Operational risk and resilience
The PRA are continuing to focus on operational risk and resilience, so why not make sure you consider how climate change risk could affect your operations. For example:
- Reputational damage arising from greenwashing or being associated with another firm or individual not acting or contributing to climate change.
- The risk of a fine for not keeping up to date with evolving climate change regulation from the PRA or governments.
- Business interruption from eg being unable to access your building due to increased flooding or the impact of temperature extremes on your plumbing.
Also, consider what secondary impacts these events may have eg it may be harder to recruit and retain staff if the company has a bad environmental record.
What the PRA did say on Climate change
On climate change explicitly, the PRA did say that they will continue to ‘assess firms' ability to meet the PRA’s supervisory expectations' and they 'expect firms to be able to demonstrate how they are responding to our expectations and to set out the steps they are taking to address barriers to progress.'
Although climate change isn't a top explicit priority right now, it certainly has not been forgotten and we expect it to be back at the top of the agenda in 2024.
We would like to see insurers shift their thinking on climate change from it being a standalone risk to acknowledging that it is a systemic issue that impacts affects overall strategy and all areas of risk. The suggestions above highlight a few quick and easy ways to do this whilst you are focussing on addressing the top priorities for the PRA in 2023.
We host regular roundtable meetings to explore climate change considerations for the insurance industry. If you would like to attend the next session this Spring, please get in touch with Jess or Lara.