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>> The impact of climate risk on the insurance industry is a cause of concern for

regulators. In the UK, the Prudential Regulation Authority has said it is planning to put increased focus on resilience to climate change and it is considering the

best approach to insurance supervision given increased risks from climate

change. What is the appropriate role for the regulator in terms of helping the insurance industry best prepare itself to cope with the challenges of climate change?

Suki Basi, Russell Group“Global climate regulations are constantly evolving from the Kyoto Protocols in 1999 to Copen-hagen in 2009 and now, the Paris Accords in 2015. Therefore, with these consistent regulatory changes, modelling has to align itself to these challenges. This is a big challenge for the industry.

“Regulatory changes will impact on society and people over time as they include not just mere ratification of the international treaty. Alongside any ratification comes implementa-tion and enforcement of these frameworks through domestic legislation and policies. The UK government’s Climate Change Act of 2008 is an example of this. Therefore, regulators’ most vital role is to provide forward guidance to insurers by offering them a clear direction, allow-ing insurers to embed the true cost of climate change into their policies.”

Karen Clark, Karen Clark & Company“Increasingly, models are being utilised to try to quantify complex risks and regulators can raise the bar on the risk models, particularly the cat models.

“Currently, the traditional vendor models are generally accepted by the regulators, but the onus is on the model users to validate the models. The problem with this is the users can’t really validate the traditional models because they can’t see what’s inside. As a result re/insurers must spend a lot of time and resources documenting what they’ve been able to infer from the mod-eller documentation and from time-consuming contrived analyses of the model output. There’s a vast amount of waste in the current system because every re/insurer must repeat the same process and then, of course, do it again when the models are updated. This is good for the mod-el vendors, but very inefficient for the model users. Re/insurers don’t gain from this process because at the end of the day, there’s too much pressure to simply accept the updated models.

“Regulators can raise the bar on the models by requiring all model assumptions, particu-larly those concerning climate change, to be fully transparent and visible to the model users. New open loss modelling platforms that allow users to look inside and actually see the model assumptions so they can be efficiently and properly verified are now available. Regulators could encourage the use of newer, open models that better inform the model users on the risk of climate change and enable more scientific and efficient modelling processes.”

Robert Muir-Wood, RMS“Understanding the impacts of climate change on the most extreme catastrophes is far more challenging than observing changes in things like mean temperatures or rainfall. We need long timeframes to observe any impact on the frequency of those catastrophes.

“The most important evidence on this has come from ‘attribution’ studies, in which global climate models are run with and without the increases in greenhouse gases since 1950, to quantify the change in frequency of some specific class of regional extreme. One key finding from such studies is no climate extreme so far observed is beyond the range of extremes that could occur within the previous state of the climate. It is simply that the probability of occur-rence has shifted – potentially to greater frequency.

“Of all the different classes of climate extremes those with the strongest signature of cli-mate  change and hence with the greatest increase in probability, are extreme heatwaves. Intense rainfall occurrence has also shown evidence for increased frequency in a number of regions. Therefore, when considering the specific extremes that could affect an insurer’s solvency, it is a matter of appropriately stress-testing the probabilities using a model. Com-pletely novel classes of catastrophe are not needed.”

Hervé Guez, Mirova“On the insurance product side, regulators could progressively encourage

insurance companies to integrate climate change issues in their stress test, including both transition and adaptation to make sure insurance companies are solid enough to face these future risks. Regulators could also favour the development of ‘green’ insurance products, meaning products with incentives which aim to promote ecologically sound be-

haviour. On the investment side, France’s Article 173 already asks in-surance companies and all institutional investors to communicate about

their environmental, social and governance [ESG] and climate-related in-vestment policies. Such regulation could be applied at European level. As such, there is a workforce dedicated to these issues at the European Commission. Another area for continued discussion is the modification of solvency ratios: as investment in the green economy should improve financial stability, capital requirements for such investments could be reduced.

“We can expect change in Europe in the future, but as long as Trump is president, similar new regulations seem unlikely to come about in the US.” n

Environmental issues are a key concern for the insurance sector following the shock election of Donald Trump in the US presidential election last November, Swiss Re has warned. This prediction appears to be confirmed by the Trump administration’s deci-sion last week to pull out of the Paris Climate Change Agreement.

In a global economic and political environment shaped by the policies of the Trump ad-ministration in the US, what are the challenges as well as the opportunities for the insurance industry? Swiss Re, for instance, while being highly critical of the administration’s approach to climate change, acknowledges that oil exploration in Alaska and the Arctic Ocean could open up new avenues of business for insurance markets globally.

>> What will be the impact of the Trump administration on the US and global

environmental risk profile?

Rahul Ghosh, vice-president and senior credit officer, Moody’s Investors Service

“The withdrawal of the US from the Paris Agreement will not stall global efforts to reduce carbon emissions, given robust institutional and private sector momentum – including technological advancements – will contin-ue to drive sustainable and climate agendas forward. Policymaking at a state and local government level will also play an increasingly important

role in fulfilling national climate commitments, including in the US. As such, the effects of carbon transition will continue to have material credit

implications for rated entities in a number of industrial sectors globally.”

Suki Basi, chief executive, Russell Group“The Trump presidency has taken a ‘Jekyll and Hyde’ approach to the environment. The Jekyll side of Trump has slashed Obama-era regulation and restarted construction on the Keystone XL pipeline. Yet the ‘Hyde’ side of president Trump is taking what could be consid-ered a more nuanced approach to the Paris Agreement, with whispers of Trump working for an increase in the emissions from 26% to 28% when the US eventually rejoins the agreement.

“For insurers looking for any patterns to understand the Trump presidency, they must take heart from Trump’s U-turn on the North American Free Trade Agreement [Nafta]. Despite branding Nafta as the ‘worst trade deal ever’, Trump promised to keep and negotiate the deal. Despite having withdrawn from the Paris Agreement, it is very likely Trump will come back and perform The Art of the Deal.”

Hervé Guez, head of responsible investment research, Mirova“Trump’s stance on climate change might lead to less regulation in the US first and potentially globally afterwards. But we do not believe it will fundamentally change the issues related to the energy transition. Climate change will lead to increased risks: sea level rise, more heat waves, agricultural concerns, new health problems, potential increases in the incidence of extreme weather. New risks mean insurance and reinsurance companies have to adapt their insurance premiums to take into consideration these changes.

“However, both insurance and reinsurance companies have to look beyond. As Henri de Castries, chief executive and chairman of Axa, said in 2015: ‘A world at +2°C could still be in-surable, a world at +4°C would surely no longer be.’ A world at 4°C hotter or more would lead to such instability that insurance companies will face strong difficulties to adapt both their insurance and investment activities.

“Therefore, insurance companies should already act beyond simply adjusting their insur-ance premium by beginning to offer insurance products that favour a low-carbon economy and questioning how their investment activities can better take climate change into account. This enables them to avoid investments in risky assets, seize investment opportunities driving economic and environmental performance while reducing the global systemic risk they face.”

>> What are the political/economic challenges and opportunities for the insurance industry because of the Trump administration’s policies?

Robert Muir-Wood, chief research officer, RMS“Above all else, the insurance industry is focused on determining the

level of risk to provide a fair price for insurance against the various climate perils. Any change in emissions of greenhouse gases today will have a negligible impact on short-term climate perils. It is the long-term impacts decades ahead for which a failure to limit emissions over many years will have consequences. In terms of the expansion of

insured risk, this will be determined by economic growth in different regions and industry sectors.”

Suki Basi, Russell Group“At first glance, it would seem bizarre to argue the Trump administration’s environmental policies have economic and political benefits. They do – but not directly. With the US adopting an ‘America First’ approach, there is a leadership vacuum on issues of the environment; lead-ership which is being demonstrated by China and India.

“Insurers need to move beyond their traditional siloed based approach and adopt roles as thought leaders and shapers of products. While geopolitical and cyber breach drivers may be established risks, environmental systemic risk can have a similar impact. This is a time of immense opportunity for far sighted re/insurers.”

Ned Kirk, partner, Clyde & Co New York“Underwriters increasingly need to ask searching questions about how

businesses are responding to climate change. There is potential for a growing volume of litigation and disputes in which corporate boards are being held to account for alleged reporting, regulatory and fiducia-ry failures linked to climate change and the fossil fuel sector.

“There are three key types of litigation that will result from climate change: companies failing to fully disclose how climate change affects

their business; shareholders, pension fund members or investors suing investment and pension funds for investing in businesses adversely affect-

ed by climate change; companies contributing directly to pollution and climate change.“It is unlikely this type of litigation in the US will be reduced, even in the wake of the election

of Donald Trump. While federal regulation in the US could be affected by a more pro-business administration, private prosecutions by shareholders and activist groups will continue.

“Litigation has already been brought in the US against an energy firm for its failure to disclose the impact of climate change after it wrote down oil and gas assets in 2016. Other actions are being considered. Regulators like the Securities and Exchange Commission have already issued guidance on climate change disclosure and are taking action against energy companies. They are also starting to look long and hard at sectors like mining, transportation and insurance.

“Underwriters need to ask themselves how they get to understand the climate change risks

inherent in these businesses. They need to ask some searching questions about how companies are dealing with climate risks.”

Simon Harris, managing director, global insurance and managed investments, Moody’s

“We see climate change and the policy response to it as presenting both opportunities and risks for the insurance industry. On the opportuni-ty side, greater appreciation of the risks presented by climate change and the new economic activity addressing or made possible by climate change, present substantial business opportunities for insurers.

“On the risk side, climate change can hurt insurers at many levels, from increased property and casualty losses to investment portfolio dete-

rioration. Such risks are mitigated in part by the insurers’ ability to reprice risk (generally) on an annual basis, but leave insurers exposed to potentially catastrophic loss-es, especially given the possible correlated nature of such losses.”

Karen Clark, chief executive, Karen Clark & Company“In general, risk is good for the insurance industry because insurance products help indi-viduals, corporations, governments and society mitigate and manage risk. The more risk, the more demand there should be for insurance, and the more opportunities for insurers.

“The major challenge with many emerging risks, such as climate change, is the impact on future insurance losses cannot be accurately quantified. Additionally, if the risk gets too high, property owners will not be able to afford the insurance coverage. For example, private flood insurance provides an opportunity, particularly now in the US. Climate change will certainly in-crease the flood risk and a viable private market could protect homeowners and small business owners from increasing vulnerability to catastrophic losses and provide the right risk mitigation incentives. But even without climate change, a widely available private flood product has eluded the industry, partly because true risk-based prices would be higher in the most vulnerable areas.”

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Mitigating the risks of climate change

Continued on p6 >>

Experts consider the implications of climate change on underwriting, regulation, risk modelling and asset management

FOCUS/ CLIMATE CHANGE www.insuranceday.com | Monday 5 June 20176 www.insuranceday.com | Monday 5 June 2017 7

>> In 2015, Mark Carney, governor of the Bank of England, warned the increasing levels

of physical risk caused by climate change could present significant challenges to

general insurance business models. Indeed, he called for unrelenting improvements

in risk modelling as previously unanticipated risks come to the fore and increasingly

volatile weather trends emerge. What are the specific challenges for the risk modelling sector with regard to the phenomenon of climate change? Does the notion of climate

change bring an additional dimension and set of challenges to the modelling of

catastrophe events such as floods, hurricanes, drought and even earthquakes?

Simon Harris, Moody’s“The main challenges to modelling climate risk relate to the substantial variability in the effects of climate change at the local level, the presence of possible climate discontinuities that are diffi-cult to model and the difficulty in adequately estimating compounded risks (for example, flood-ing risk as a combination of rising oceans, more intense rainfall, land subsidence and inadequate infrastructure) and correlation of risks as a result of the global nature of climate change.”

Miroslav Petkov, director, Standard & Poor’s Global Ratings“Catastrophe modelling is a complex process that is influenced by numer-

ous estimates, assumptions and subjective judgments. We consider there is a significant modelling uncertainty when estimating cat losses under extreme events. The impact of climate change is likely to increase that uncertainty. Until a consensus emerges, we don’t expect the industry to directly allow for the impact of climate change. We agree with some of

the views that while climate change is expected to have a material im-pact on extreme weather, this impact is likely to emerge in the long term.”

Robert Muir-Wood, RMS“Climate change clearly brings an additional dimension to catastrophe loss modelling, as we can no longer simply assume the occurrence frequencies of extreme events remain stable through time. Inevitably, this brings additional uncertainty to the quantification of catastro-phe risks, as we will have shorter timeframes of observations to compare with modelled results. However, we already encounter many of these challenges in modelling when we find multi-decadal shifts in event occurrence in Atlantic hurricane activity or even in the population of extreme windstorms that arrives in north-west Europe, where there has been an overall reduction in extreme storm activity since the 1990s.

“Two years ago, RMS was involved in the Risky Business initiative, first in a technical advi-sory capacity, then to employ RMS proprietary hurricane wind and surge catastrophe models. We were considering both anticipated sea level rise and shifts in hurricane activity and inten-sity as derived from climate model projections to quantify changes in anticipated modelled losses for US coastal risks through to the end of this century.

“Perhaps the most notable outcome of this work was to reveal the economic implications of the uncertainty in these projections. This uncertainty in loss costs becomes greater the further one looks into the future. It is all too easy to employ a single model for the future, and come up with headline projections about the magnitude of change in sea level or hurricane costs. But the reality is that there is significant uncertainty.”

Karen Clark, Karen Clark & Company“Even without a changing climate, there is wide uncertainty around the

risk models for natural catastrophes.  Because severe events, such as floods, are relatively infrequent in specific geographic areas, there’s a paucity of information for loss estimation and model developers must make assumptions based on expert judgment rather than observed and verifiable data. 

“Not surprisingly, when there is sparse data and wide uncertainty in the models, there is low confidence in the model-generated loss estimates.

Insurance loss models, including the cat models, are based on and rely upon data. The only way to reduce the uncertainty is to collect more data, which can only happen over time. No matter how many scientists work unrelentingly on the models, the wide uncertainty will remain. Attempting to project the future impacts of climate change on catastrophic events simply adds another layer of uncertainty to the models.

“No scientist or model can give ‘the answer’ and we need to think about the models differ-ently. The value of a cat model is in the rigorous structured approach to loss estimation using an event catalogue, intensity module, vulnerability functions and a financial loss module.

“The components of the cat models are consistent from vendor to vendor and update to update. It is the assumptions that underlie those components that differ, mainly because dif-ferent scientists have different opinions. Therefore, the most robust and credible way to incor-porate climate change into the cat models is for the model developers to provide alternative sets of fully transparent assumptions reflecting the full range of projections provided by the Intergovernmental Panel on Climate Change [IPCC].

“The cat models cannot provide definitive answers, they provide loss estimates based on sets of assumptions. That’s why model vendors should provide alternative sets of transparent assumptions reflecting the scientific consensus in the IPCC reports. In this way, model users and decision makers can see exactly how their loss estimates are impacted by the credible range of assumptions.  It doesn’t serve the industry well for model vendors to embed their own assumptions and a single view with respect to climate change.”

Hervé Guez, Mirova“As an investor, we certainly expect insurance companies we invest in to demonstrate how they take into account these new risks, both on the adaption side (for example, to hurricanes, drought, floods and so on) but also on the mitigation side (transition risks, like stranded assets).

“It is also worth quoting Mark Carney: ‘Achieving the SDGs [sustainable development goals] will require mainstream finance. We need to build a new system – one that delivers sustain-able investment flows, based on both resilient market-based, and robust bank-based, finance. We need finance for the long term.’ In line with what we have previously indicated, insurance companies also have a role to play in financing a 2°C world.”

Suki Basi, Russell Group“The connected planet in which we live, trade and manage resources is be-

coming more fragmented, dangerous and unpredictable. The challenge for the risk modelling sector is to evaluate the interplay between four main drivers – environmental, economic, social and political – with a focus to identify, forecast and predict the relationship between societal unrest, often driven by environmental factors and political instability

across the world and their impact on long-term business risk.“To effectively evaluate these drivers, it is important to identify and assess

both top-down and bottom-up drivers. Many risk modellers, including forecast-ers and insurance industry professionals, have been using for some time indices that align to that basic premise of the top down drivers of risk. These top-down drivers include legal and regulatory frameworks, rule of law and corruption metrics. Bottom-up drivers are those devel-opment issues that affect the lives and wellbeing of people and society over time – such as en-vironmental degradation caused by climate change, human rights, resource security, economic diversification and so on.

“A true analytical model will need to be developed that can predict how the confluence of these various factors can and will impact on long-term business risk.”

>> The Financial Stability Board’s taskforce on climate-related financial disclosures

was established in 2015 to develop voluntary, consistent, climate-related financial

risk disclosures to be used by companies to provide information to lenders, insurers,

investors and other stakeholders. How practical is this vision of a set of voluntary

climate change disclosure principles and leading practices for financial services

companies, including, of course, for insurers?

Miroslav Petkov, S&P Global Ratings“Even though the disclosure requirements are going to be voluntary, we expect there will be sufficient investor pressure for insurers to provide the disclosure given the importance of cli-mate change risks for their business and financial profile. Already two insurers were among the first companies to provide disclosure in line with the recommendations. Nevertheless, we expect that it may take some time before the disclosure is comprehensive and performed on a consistent basis.”

Simon Harris, Moody’s“The Taskforce on Climate-Related Financial Disclosures [TCFD] completed a public consul-tation in February of this year following the release of its report – Recommendations of the Task Force on Climate-related Financial Disclosures – in December 2016. The TCFD’s final report will provide a set of voluntary, consistent disclosure recommendations for use by companies in providing information about the financial impacts of climate change with a

focus on four thematic areas: governance, strategy, risk management and metrics and tar-gets, including the application of scenario analysis to assess carbon transition and physical risks. The final report and recommendations will be published in June 2017 and presented at the G20 Summit in July of the same year. The recommendations are expected to be ad-vanced by international and national financial authorities and international standard-set-ting bodies. While adoption is voluntary, the TCFD has proposed to continue its work until at least September 2018 with a focus on promoting and monitoring adoption of the TCFD’s recommendations, as well as evaluating their utility. At the same time, the TCFD’s initiative is expected to be reinforced and will likely gain further traction as asset owners, investors and other interested parties continue, either directly or indirectly, to advocate for greater environmental risk disclosures.”

Suki Basi, Russell Group“Insurers would be foolish regardless of the scepticism on climate change to ignore the opin-ions held by potentially millions of their customers who believe in climate change.

“Despite the critics, the reality is some of the world’s largest corporations – including huge multinational corporations like Exxon-Mobil – take climate change very seriously, so seriously they are lobbying president Trump to keep the US in the Paris accords.

“Swiss Re is probably one of the best examples of a corporation that has announced it will adopt the climate-related financial disclosure recommendations of the TCFD. As a member of the TCFD, Swiss Re helped develop these voluntary guidelines on climate-risk reporting. Thus, giving transparency on climate-related risks to employees, investors and clients a like. Such an approach, I believe will only grow over time.”

Hervé Guez, Mirova“The taskforce has established a consistent reporting scheme that defines the basis for volun-tary, consistent, climate-related financial risk disclosures to be used by companies to provide information to financiers. It remains a challenge for the TCFD to develop an appropriate set of quantitative and qualitative metrics, as well as an appropriate ecosystem of players to deliver relevant information deprived of potential conflict of interests. We consider that:• The works of the TCFD require more elaboration on ‘who should deliver what’ to provide a

practical vision and useful information. For instance, information related to climate physi-cal risks shall be disclosed directly by companies to investors to assess the risks of financial losses related to extreme weather events. Conversely, the viability of a business model in the context of energy transition and climate change adaptation should be assessed directly by intermediaries like rating agencies. These intermediaries also have a role to play to under-stand and render issuer information comparable.

• The works of the TCFD may also simplify the information requested and make it more comprehensive and relevant to help lenders, insurers, investors and other stakeholders understand how much a company is contributing to reduce and mitigate the impacts of climate change. Adapted methodologies which integrate both qualitative data and quantitative indicators through scopes 1, 2, and 3 as well as avoided carbon emissions are needed.

• The principles of climate change disclosure and leading practices for financial services should be aimed at preserving the global economy from the physical risks associated with climate change; in other words, a practical vision of climate disclosure for financial services

should help to develop an understanding as to how much these companies contribute to increasing or decreasing the impacts of climate change through their investment strat-

egies and strategic choices. Implementing such disclosure could come from devel-opment of regulations based on the French article 173 regulations, for example.”

Robert Muir-Wood, RMS“Voluntary and qualitative disclosures are the first step to normalising re-porting for climate change-related exposures and are a necessary precursor to mandatory, quantitative assessments. Climate change will have multiple impacts, whether through the move to sustainable energy or through new regulations, or from the impacts of climate extremes. It will be important insurers remain focused on considering all these potential impacts on their business model.” n

Continued from p5

>> Given the tough financial market and investment environment, how feasible is it for

insurance companies and their asset managers to consider the specific environmental

characteristics of assets in their portfolios and to stress-test investment portfolios to

build a picture of their potential exposure to stranded assets?

Simon Harris, Moody’s“Re/insurers typically invest in bonds that match their liabilities and have broad diversified portfolios that include exposure to sectors affected by environmental risks. However, active portfolio management, including managing credit risks, is a core strength of the industry.”

Suki Basi, Russell Group“It is very feasibly for insurers to consider the environmental characteristics of their assets and increasingly achievable in practice as demonstrated by Swiss and Munich Re.

“Swiss Re has incorporated the ESG criteria into its investment approach as part of its focus on sustainable and attractive risk-adjusted returns. Furthermore, Swiss Re along with other insurance carriers is participating in climate change research projects.

“Other carriers like QBE also appear to be putting their money where the mouth is via projects such as their Premiums4Good [P4G] initiative, allowing customers to make a lasting difference to the environment. This is achieved by the customer allowing a percentage of their premium to be invested into selected securities with social or environmental benefits such as social impact or green bonds.

“Both the investment risk and cost is borne by QBE. Despite, the current disregard for experts, it would take a brave individual to bet against a multinational insurance company. Insurance companies are understanding the marketing and economic benefits of acting and being seen to be green.”

Miroslav Petkov, S&P Global Ratings“We do not consider that insurers are materially exposed to the risk of stranded assets directly based on our analysis. Insurers typically have relatively low-risk and well-diversified invest-ment portfolios with a high share of government bonds, while life insurers often have the abil-ity to share investment profits and losses with their policyholders.

“At the same time we consider climate change has the potential of triggering a macro-economic shock as it could affect the global economy, international political stability and financial systems in many different ways.

“These effects could accumulate, triggering a sharp deterioration in the overall macro-economic and financial environment. In such a case, the aggregated cost could be a mul-tiple of the cost directly associated with climate change. For example, if stricter carbon dioxide emissions limits are imposed suddenly, the profitability of carbon-intensive sec-tors and the value of assets in those sectors could immediately see a material deteriora-tion. The effect could spread to the wider economy and the financial sector, triggering a crisis. This is why in our opinion it is important for insurers to understand their exposure to those risks.” n