Earlier this year, the Network for Greening the Financial System (NGFS) conducted a survey for users of their climate scenarios. The results were published in early June 2023, and offer insight into the types of organization using their climate scenarios. The results cover how and why these institutions perform climate scenario analysis, and the types of risk they assess.
The most important findings from the survey are that many organizations are unclear on how to use climate scenarios, and identify or assess the variables that are most relevant to their organization. In addition, the survey identified that increasing sectoral granularity and geographical coverage is a priority for improving the NGFS scenarios.
In this article we consider the use of climate scenarios from an insurance perspective to understand the financial impact of climate change.
For example, an insurer incorporating climate risk into their Own Risk and Solvency Assessment (ORSA) process, or an asset manager performing climate scenario analysis as part of a Strategic Asset Allocation (SAA) stress testing exercise. Either must understand how the projection of variables that the climate scenarios produce (such as carbon dioxide emissions, temperature increases, and carbon prices) are likely to impact the financial and economic variables that are important to understanding their business risks.
This challenge in translating climate scenario model outputs into the variables and metrics that financial organizations typically monitor, can act as a blocker when incorporating climate risk into important business processes (for example, ORSA and SAA exercises).
The NGFS survey results also highlight that for organizations already performing climate scenario analysis, the potential for future regulatory requirements is a motivation for them to build capabilities and expertise in this area. This is expected soon for European insurers, given the recent announcement by the European Insurance and Occupational Pensions Authority (EIOPA). The guidance by EIOPA sets an expectation for insurers to integrate climate change risk into their governance, risk management, and ORSA processes. The guidance requires using at least two long-term climate scenarios. In other regions, one-off mandatory regulatory exercises; such as the Climate Biennial Exploratory Scenario (CBES) exercise in the UK and the forthcoming standardized climate scenario exercise being conducted by the Office for Superintendent of Financial Institutions (OSFI) in Canada, have indicated that climate risk analysis is becoming an increasingly critical area of focus for regulators.
In order to address these challenges, Moody’s Analytics has developed the Climate Pathway Scenario Service.
Our Climate Pathway Scenario Service uses scenario generation to facilitate customers’ efforts to respond to ORSA and TCFD requirements. It helps insurers to quantify the financial impact from climate related physical and transition risks. Combining our financial modeling framework with the best climate science consensus, enables customers to understand the financial impacts of climate change, which is a significant focus area for the future. Bringing together our expertise in climate, natural catastrophes, economic and market risk offers insurers a deeper understanding of a more integrated approach in this challenging area. The scenarios can also support integration of climate risk into strategic asset allocation (SAA) and investment selection processes.
The service captures the impact on market and credit risk associated with each temperature path and covers a large range of financial outputs and assets returns for a wide range of asset classes (both on a geographical and sector basis).
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