Wider collaboration key to meeting climate risk challenge

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31 March 2020 | 5-minute read 

Climate change is a top-level concern for individuals, businesses, governments and regulators around the world. As insurers and reinsurers, we are affected both by the need to meet emissions targets and the need to deal with the risks that climate change poses and how those risks can be managed and transferred. 

It is, we believe, time for the Lloyd’s market to increase its profile in the public conversation around this topic. Working together with large insurers, we need a dialogue with both regulators and the public about the risks of climate change as well as to challenge the preconception that the non-life insurance industry is not interested in the long-term issue since it re-prices contracts every year.

There are other traps to avoid. For example, misleading or ill-thought-out disclosures of the risks and opportunities from climate change in financial statements, may mean that risks are inaccurately priced into financial assets, such as stocks. 

Looking further ahead, there may also come a time when it becomes necessary to push for some sort of implicit state guarantee, such as exists for the banking industry, to support insurers in their vital role as “the invisible banker”. 

The LMA offers a space for managing agents to share thoughts, experiences and ideas and so is ideally placed to facilitate dialogue about climate change and the insurance and reinsurance industry. Therefore, the LMA is launching a cross-functional Working Group for members to collaborate on approaches to climate risk analysis and to develop a narrative which helps promotes better understanding of the climate change risks and opportunities that affect our industry.

Five years ago, the Prudential Regulation Authority issued a paper highlighting climate-change risks to the insurance sector. These they divided into three principal categories: physical risks (storms, floods, heatwaves), transition risks (primarily re-pricing of carbon-intensive financial assets), and liability risks (third-party losses which span the other two categories).

Those physical risks are related to weather events such as windstorm, flooding, rising sea-levels and heatwaves. Our industry’s ability to adapt to these changes is largely focused on the evolution of catastrophe risk models to incorporate future trends and model events that have not previously been modelled and for which there is limited historical data.  But attention also needs to be given to changing business models to adapt to climate change - for example to mitigate adverse loss experience by diversifying portfolios. 

There are transition risks that we must consider too. These focus on the transition to a low carbon and - ultimately - a net zero carbon economy. Transition risks tend to focus on the invested asset side of insurers’ balance sheets. It seems that transition risks are not yet being priced into the share prices of companies such as oil and gas corporations - this is probably because these risks are so long-term in nature and remain so uncertain. 

But there are a number of scenarios that could act as triggers for transition risks to be realised, such as a public policy change or a groundswell of public opinion that might lead to a ban on the use of certain fossil fuels or impose significant new disclosure requirements. A technological breakthrough could also trigger a rapid move away from fossil fuels towards renewable energy sources.

Liability risks have hitherto been less of a focus, but there are signs now that climate-change-related claims could be made under liability coverages. Claimants are already exploring potential lines of argument to access liability coverages, such as a failure to take emissions reducing mitigating action or a failure to adapt to climate risks. It is important here to heed the lessons of the past - asbestos and pollution risks have shown us how disruptive long-tail liability risks can be to our industry. 

As regulators start to strengthen disclosure requirements an additional avenue for liability claims will crystallise around failure to adequately comply with those requirements. 

As the insurance industry grapples with these varying implications of climate change and the attendant analysis and disclosure requirements, the LMA can provide a safe and non-competitive space for managing agents to come together and share ideas. 

This collaboration is likely to become even more important as Lloyd’s considers its oversight of the market on either disclosure requirements or scenario analysis. Managing agents will need to work closely with Lloyd’s to ensure that there is no conflict between what Lloyd’s requires and individual group Environmental, Social and Governance (ESG) policies. 

At the LMA we will continue to work closely with managing agents by expanding our  Financial Impacts of Climate Change Working Group - to ensure that we are all ready to meet the challenges that may lie ahead. This group is being relaunched with representatives from relevant disciplines such as Risk, Underwriting, Exposure Management and Finance. We will work to make the voice of the Lloyd’s market heard by regulators, governments and the public.

If you would like to get involved, please contact me.

Paul Davenport
Finance & Risk Director

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