The Risk Management workstream of the IFOA’s Life Board Climate Risk Working Party is tasked with looking to support life insurers with embedding climate change risks into their risk frameworks. As this is a very broad topic, the scope was limited to key pillars of the risk management framework, such as risk governance, risk appetite and stress and scenario testing. The finer details of modelling the impact of climate change risks on assets and/or liabilities are covered by other workstreams of this working party.
Our initial goal was to identify and review papers relevant to embedding climate change risks into a life insurer’s risk framework, taking an international perspective. Most of the papers were either a) issued by regulators containing their expectations/guidance b) stress and scenario testing related (with much of this also being driven by regulatory activity) or c) guidance for companies directly aimed at providing some practical advice. There were several other miscellaneous papers identified which were categorised into a fourth category of d) Other. It is important to note that this area is constantly evolving, with new papers published on an ongoing basis. It is advisable to check for any more recent updates before using any of the papers referenced here.
The review of the papers setting out regulatory guidance/expectations on the risk framework found many of these to be quite similar in this area. Most of the content is high level and does not provide much substance to use in practice. The following papers were considered the most useful from the list of papers reviewed. These were selected from the viewpoint of a risk practitioner looking to embed climate change risks into their organisation’s risk framework, irrespective of location. This is not intended to imply that the remaining papers are not useful from other perspectives e.g., anyone working in a particular country will need to be familiar with the views/requirements of their own local regulator.
Insurance Industry Perspectives on Regulatory Approaches to Climate Risk Assessment | Issue brief | Geneva Association – this provides a good overview of many of the regulatory approaches taken to date. The paper outlines the Geneva Association’s recommendations for improving regulatory risk assessments and scenario analyses. These could potentially be useful for companies who are looking to design scenario analyses themselves rather than rely on external providers.
Sustainable Insurance Forum (SIF) - Question Bank on Climate Change Risks to the Insurance Sector – whilst there is no specific guidance on how to embed climate risk into an insurer’s risk framework, there are several questions on risk management and stress and scenario testing which could help insurers scope their work and/or validate the processes that they propose to put in place.
IAIS Application Paper on the Supervision of Climate-related Risks in the Insurance Sector – sets out international regulatory guidance and expectations in terms of supervisory review and reporting, corporate governance, risk management, investments, and disclosures. Again, this could be used to help insurers scope their work and/or validate the processes that they propose to put in place. This includes how climate risks are assessed and how these risks impact on investment, underwriting, and decision-making processes. Challenges with data availability and quality are discussed as well.
Key elements of the 2021 Biennial Exploratory Scenario: Financial risks from climate change | Bank of England - the aim of the scenario analysis exercise is to assess the resiliency of the UK financial sector (both banks and insurers) to a consistently applied set of climate-related scenarios (covering both physical and transition risks). The main objectives of the CBES are to evaluate the exposures of the participants and the financial system as a whole to climate risks, understand the challenges to the participant's business models from the risks covered, and assist participants in better understanding their exposure to climate-related risks.
While UK-focused, the exercise could be used by international companies to broaden their understanding of climate risk and its impact on their business, as well as an opportunity to develop skills and knowledge for managing these risks. It’s worth pointing out that the French regulator (ACPR) has already concluded a similar exercise with useful lessons set out in the ACPR paper A first assessment of financial risks stemming from climate change: The main results of the 2020 climate pilot exercise.
The review of the papers on stress and scenario testing again found a lot of overlap between them. It was felt that the best place to start in understanding climate risk scenarios is the technical documentation behind the Network for Greening the Financial System’s (‘NGFS’) climate scenarios database, published in June 2021. This explains the 6 NGFS reference scenarios in some detail. These scenarios can be used to form the basis of stress and scenario testing exercises. Practical guidance on implementing climate scenario analysis has been published in the UK Climate Financial Risk Forum Scenario Analysis Guides 2020 and 2021.
In terms of embedding climate risks into risk frameworks in general, by far the most practical papers reviewed were the Guides published by the Climate Financial Risk Forum in the UK. The latest guides published in October 2021 include detailed advice on incorporating climate risk into risk appetite statements, use case examples, climate risk training, and thoughts on actual and potential climate risk metrics. There are sections specifically aimed at insurers, however, there is information in the sections aimed at other financial services sectors that is likely to be more widely applicable and is therefore worth reading. For example, life insurers may wish to use information in the sections aimed at asset managers in discussions on their investment portfolios and/or unit-linked fund offerings. Life insurers offering protection products linked to mortgages may find the banking case study informative in considering second-order climate change impacts on sales/persistency.
For useful information on how to choose and develop risk metrics for assessing and monitoring climate risk the Milliman white paper Risk metrics for climate change, Climate change risk monitoring: Which metrics and why? provides a good overview with examples given. The paper is based on a 2019 survey of around 40, mostly UK-based, insurers. It could be helpful for companies looking to develop and introduce metrics for climate risk monitoring.
Another paper considered worth highlighting here is the CRO Forum’s position paper The heat is on, Insurability and Resilience in a Changing Climate. Although published in 2019, this paper very clearly articulates the case for urgent action. It is written in the context that society must work together globally at all levels to reduce carbon emissions. The authors are skeptical on the use of carbon offsets. Some of the material could be used for training/advocacy within organisations.
This is the first blog of a series focusing on specific aspects of embedding climate risk into an insurer's overall risk management framework. We would be very interested in hearing about the challenges that life insurers are facing in this area, to help guide future research.
