The Financial Stability Institute (FSI) of BIS published a paper that examines the regulatory approaches being used for climate risk assessment in the insurance sector, in particular through enterprise risk management (ERM) frameworks. The paper describes how some supervisory authorities have undertaken climate risk assessment exercises, focusing on the stress test and the scenario analysis approaches. The paper finds that risk-quantification techniques and models that consider climate risks are more advanced for physical risks, but are still at an early stage for transition and liability risks. Other key policy issues that require consideration include the impact of climate risks on access and affordability of insurance products and the potential use of capital requirements to address climate risks.
Although efforts have been made by insurance supervisors and insurers in some jurisdictions to better understand climate risks, further efforts are needed. This paper covers climate risk assessment from both regulatory and supervisory perspectives. Based primarily on a survey of 18 insurance authorities, the paper describes the range of regulatory approaches that specify how insurers are expected to assess their climate risk exposures and techniques that supervisors can use to conduct their own assessment of climate risks. Using tools such as stress testing and scenario analysis, supervisors can take steps to better understand how climate risk could impact the financial and solvency position of insurers as well as the financial system.
The paper highlights that undertaking climate risk modeling and the associated governance processes can facilitate helpful discussion on risk strategy within an insurer, which some may argue as being more important than the numerical results from the models. Although, at present, few authorities undertake supervisory or system-wide stress tests that explicitly cover climate risk, supervisors appear to have a growing interest in including climate-related events in such exercises. Despite technical and operational challenges in undertaking climate risk assessment by insurers and supervisors, it is important to take the first step while recognizing that initial efforts will not be perfect. It remains unclear if capital adequacy requirements are appropriate to address climate risk exposures of insurers. Climate risk scenario analyses or stress tests undertaken by supervisors are not aimed at determining any capital buffers that might be required against longer-term climate risk exposures. Rather, they are used as a learning tool to help insurers prepare themselves for potential future climate scenarios.
As climate risk quantification techniques mature and insurer risk assessment becomes more accurate, certain policy issues will need to be carefully considered. Looking ahead, there is room to enhance international cooperation among insurance supervisors and other climate-related forums to improve understanding of climate risks and their potential impact on insurers, policyholders, and financial stability. Such initiatives can build on the work done by IAIS, the Sustainable Insurance Forum, and the Network for Greening the Financial System. Supervisors can enhance their technical expertise by taking advantage of the capacity building efforts offered by various international bodies.
Related Link: Paper
Keywords: International, Insurance, Stress Testing, Capital Requirements, Governance, ERM, Physical Risks, Transition Risks, Climate Change Risks, FSI, BIS
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