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18th November 2020
PRA issues a response to industry feedback on "A framework for assessing financial impacts of physical climate change"
This report outlines the Prudential Regulatory Authority's(PRA) response to industry feedback received on the framework for assessing financial impacts of physical climate change report.
The PRA thanked those who provided feedback on its publication "A framework for assessing financial impacts of physical climate change: A practitioner’s aide for the general insurance sector". The PRA considered the feedback provided and reflected on how to address it within the context of the Bank’s current and future climate workstreams. This response summarises the main feedback points received and areas where further development is recommended.
The feedback provided a consensus that both the guidance and methodology included in the framework are valuable, and useful in the assessment of physical climate change risk for the general insurance industry. The case studies provided were seen as being very helpful in guiding firms through the different steps identified by the framework, and facilitating progress that is already visible since the publication of the report.
On the research element of the framework, there were concerns raised on the ability of firms to analyse and interpret scientific literature themselves, especially given the different views represented in different studies. This particularly seemed to be the case for smaller firms with limited resource available for these activities.
Feedback also suggests an appetite for a similar framework on the assessment of risk on the asset side of the balance sheet. It was raised that the catastrophe modelling practice, which is widely used in the insurance industry, as well as other approaches that have been developed and are coming into common practice, could be applicable for assessing the financial impacts of physical climate change risk in other contexts. An example could be the asset and investment side of insurers’ balance sheet and/or for other types of financial firms.
Other feedback received includes:
-a need for guidance to help assess the current model calibrations and whether these accurately represent climate change to date;
-the value in having a more streamlined expert judgement method for the expert to use when assessing impacts from physical climate change; and
-recognition that impacts from physical climate change include opportunities as well as risks.
As a result of this feedback, areas that are recognised as deserving prioritisation for further development are:
-assessing each hydro-meteorological region-peril in detail, and commenting on their future climate projection characteristics, acknowledging that it may not be possible to always find an academic consensus for such projection characteristics. To this end, the Bank of England is actively working to promote the latest scientific developments in a format that can be more easily consumed by central banks, supervisors and the broader financial sector as part of its involvement in the Network of Central Banks and Supervisors for Greening the Financial System.
-assessing how current catastrophe model calibrations allow for climate change that has crystallised to date. To this end, the PRA will explore that aspect further within the definition of the physical climate variables issued as part of the 2021 Climate Biennial Exploratory Scenario.
-assessing how the insurance industry’s experience on quantifying physical climate change risk on the liability side of the balance sheet could be used to develop a similar framework for assessing the risk on the asset and investment side of the balance sheet. To this end, the Climate Financial Risk Forum’s guide includes dedicated sections (refer to sections 3-6 of the Risk Management Chapter) that discuss how the data, tools and processes used by general insurers can assist other aspects of financial institutions’ climate risk management.
The PRA will:
-continue to engage with insurance firms on their progress with embedding the supervisory expectations as set out in its Supervisory Statement (SS) 3/19 ‘Enhancing banks’ and insurers’ approaches to managing the financial risks from climate change’ and in Sam Woods’ letter to all PRA-regulated firms ‘Managing climate-related financial risk – thematic feedback from the PRA’s review of firms’ SS3/19 plans and clarifications of expectations’, published on 1st July 2020.
-consider whether a follow-on report to A framework for assessing financial impacts of physical climate change: A practitioner’s aide for the general insurance sector" is required that deepens, broadens or updates its content. Decisions in this regard will be driven by observations of progress across industry(for example through firms’ progress against SS3/19 expectations) and results from other climate exercises(for example the 2021 Climate Biennial Exploratory Scenario).
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