The transition to Net Zero is the third key issue affecting discussions of prudential regulation – and in which regulators in the UK, EU and US are heavily invested.
The newly created International Sustainability Standards Board (ISSB) has been consulting on new sustainability reporting standards to build on the framework of the Task Force on Climate-Related Financial Disclosures (TCFD). In the UK, the long-awaited Financial Conduct Authority consultation on sustainability disclosure requirements has been published, and the government plans to introduce requirements to comply with the long-awaited standards of UK taxonomy and the ‘ISSB.
Prudential regulators are primarily focused on the risk to the balance sheets of a broader economic transition. This was explored in detail at the recent Bank of England Climate and Capital Conference, and in the Next letter “Dear CEO” of PRAwhich highlighted its thematic findings during the first year of active monitoring of this risk by the PRA.
The Bank of England’s Biennial Climate Exploratory Scenario (CBES) found that climate risks could lead to a persistent and significant decline in annual profitability of around 10-15% on average, if insurers do not respond effectively to change. climatic. This would make individual businesses, and the financial system as a whole, more vulnerable to other future shocks.
Insurers will need to increase their investments in data and modeling capabilities to assess how their counterparties might be affected by transition or physical risk. On the liability side, there is a need to develop their internal capabilities to incorporate a range of physical risk variables and avoid over-reliance on third parties.
In addition to climate transition plans, companies will need to carefully consider the management actions available under different scenarios. They may even want to consider whether their portfolios need to be adjusted by pulling out of carbon-intensive industries such as fossil fuels. As the CBES exercise showed, however, there could be macroeconomic consequences if the withdrawal of insurance outpaces new investments in sustainable energy.
Insurers must therefore be sensitive not only to their own business challenges to adapt to the green agenda, but also to the challenges of the insurance market in general, as well as to the broader macroeconomic environment. One option would be for insurers to develop recovery plans: a toolkit of management actions to restore progress towards their climate transition goals.
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