Developed by industry and regulators, aim is to help insurers draw up management approaches to climate risk
The Bank of England (BofE) yesterday issued new guidance to help insurance and reinsurance companies measure and assess the financial risks posed by climate threats such as heatwaves, floods, wildfires and storms.
The guidance, which aims to "unlock the shift from awareness to action" on climate change, was developed by a working group made up of finance experts, insurance firms and industry regulators the Prudential Regulation Authority (PRA).
It sets out a six-stage framework to help the sector develop scenarios and risk management approaches to extreme weather, which is expected to become more frequent and severe as global temperatures rise.
It follows warnings last month from BofE governor Mark Carney about the severity of the threat posed by climate change to the financial sector, which he said needed urgent reforms to "raise the bar" on risk measurement to avoid economic catastrophe.
UK insurers have also been asked by the BofE and the Prudential Market Authority (PRA) to stress-test how they would be impacted be a range of different physical and transition risk scenarios, amid fears that few companies in the sector systematically conduct detailed climate scenario analysis.
Yesterday's guidance is therefore designed as a starting point for insurance practitioners to begin assessing physical climate risk in the context of their business decisions and disclosure requirements, using tools already available within the sector, according to the report.
"Losses related to physical risk factors directly affect insurance firms' liabilities through higher claims, and physical risks may extend beyond the immediate impact of natural catastrophes, for example through the disruption of supply chains," explains the report.
It follows a number of major warnings about the impact of climate change on company liability and the insurance sector since the turn of the year. In the World Economic Form's global risk assessment in January, extreme weather, natural disasters and the failure of climate change mitigation measures dominated its list of the greatest business threats facing the world today.
That followed the decision just days earlier of Californian energy supplier Pacific Gas and Electric (PG&E) to file for bankruptcy after devastating wildfires in the state left the company with tens of billions of dollars in liabilities.
Yesterday's BofE guidance was developed by a working group made up of a range of industry figures from Aviva, Lloyd's of London, risk modelling firm AIR, environmental risk specialist Ambiental and the PRA, among others.
It is aimed at all general insurance firms and reinsurers, particularly practitioners involved in climate and natural catastrophe risk assessment, and acknowledges the challenges faced by them in developing climate risk strategies "beyond the usual planning horizon" amid inherent uncertainties.
Writing the foreword to the report, the PRA's executive director of insurance supervision David Rule stressed that "climate change, and society's response to it, presents financial risks to insurers", adding that such risks "are already becoming apparent".
"Assessing financial risks from climate change is not trivial given the inherent uncertainty of long-term climatic model predictions, the lack of data, and the limitations of existing tools," he wrote. "We know from our supervision of general insurers that they are well placed to contribute towards this assessment by drawing on their expertise in modelling extreme weather risk. Harnessing this expertise can unlock the shift from awareness to action."
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