Modest slowdown in premium growth distinguishes second-quarter financial results for MPL specialty insurers
We look at the financial results for medical professional liability (MPL) insurers for the second quarter of 2022.
The last year has seen many regulators, supervisors and central banks bring climate-related risks to the forefront of their agendas. Climate change, and climate-related risks, are increasingly seen as important topics within the financial services industry. This briefing note summarises the latest developments in Ireland and sets out some examples of how the expectations of the Central Bank of Ireland (CBI) can be achieved.
On the 3 November 2021, the CBI wrote to all regulated financial services providers, including (re)insurers, setting out its expectations regarding climate and other Environmental, Social and Governance (ESG) issues.1
The CBI’s letter was timely as it coincided with the publication of the Irish government’s Climate Action Plan.2 The Climate Action Plan aims to reduce greenhouse gas emissions by 51% by the year 2030 and reach net zero by 2050 at the latest. Once adopted, the government will use the overall budget to set emission ceilings for each sector of the Irish economy.
The CBI expressed that it considers climate change as a strategic priority and that the financial services industry must not only be resilient to climate-related risks but also play an important role in serving the needs of consumers and the wider economy as we transition to a carbon-neutral future. This echoes the sentiment of the UK’s prudential regulator, that the financial services industry should be a force for good in the climate change crisis.
The CBI expectations are to be applied to regulated financial services providers in a proportionate manner, aligned to the nature, scale and complexity of the individual firm. Consequently, its expectations are not prescriptive in nature and are not set out at a granular level of detail.
The CBI's expectations focus on five key areas:
|Governance||Boards need to demonstrate that they have clear ownership of climate risks affecting their firms and promote a culture that places emphasis on climate issues.|
|Risk Management||Firms are expected to understand their climate risk profiles and enhance existing risk management frameworks to ensure identification, measurement, monitoring and mitigation of climate-related risks.|
|Scenario Analysis||Scenario and stress testing are critical to assess the impact of potential future climate outcomes, including impacts on capital.|
|Strategy Risk||Firms are expected to undertake business model analysis to determine the impacts of climate risks on the firm’s risk profile and business strategy and to inform planning.|
|Disclosures||The CBI emphasised the importance of transparent disclosure to consumers and investors to protect their interests and the wider market’s integrity. Firms need to ensure they do not engage in “greenwashing.”3|
While the CBI’s expectations are not legally binding, they are based on international best practice. For the insurance industry, the European Insurance and Occupational Pensions Authority (EIOPA) issued its opinion on the treatment of climate-related risks in the own risk and solvency assessment (ORSA) to supervisory authorities in April 20214 (see here for more information). In its opinion, EIOPA sets out expectations in relation to scenario analysis and updates to risk management frameworks, and it has stated that it will begin to monitor compliance with its opinion from April 2023. Following on from this, on 10 December 2021, EIOPA published a consultation paper on the application guidance on running a climate change materiality assessment and the use of climate change scenarios in the ORSA.5 For more information on this consultation paper we have produced a briefing note to summarise the key points. It is expected that the CBI will want to ensure that Irish (re)insurers are aligned to the EIOPA guidelines, at a minimum.
The CBI’s expectations are similar in nature to those set out by other bodies in relation to climate-related risk, including the Prudential Regulatory Authority (PRA) in the UK and the Task Force on Climate-Related Financial Disclosures (TCFD).6 The TCFD is a guidance framework that helps companies disclose climate-related financial risks to investors, lenders and insurers. The PRA’s Supervisory Statement 3/19 (SS3/19),7 published in April 2019, sets out the following key areas of focus in relation to insurers’ approaches to managing the financial risks associated with climate change: governance, risk management, scenario analysis and disclosures.
Similar to the CBI, the New York Insurance Department published guidance for New York domestic insurers on managing the financial risks from climate change8 on 15 November 2021. Its supervisory expectations are aligned with those of the PRA and the CBI. Going forward we expect to see more and more regulators release guidance on climate-related risks. Although best practise is still developing in this area, we are seeing trends in the key areas that supervisors are addressing in their guidance to insurers.
In this section we set out some examples of how the CBI’s expectations can be met.
Firms need to demonstrate clear ownership by the board of climate risks affecting the firm. The board needs to oversee climate risk proactively through business strategy and risk appetite, with adequate resourcing and clear roles assigned for boards, committees, and senior management. In the UK, firms are required to assign a specific owner for managing the financial risks associated with climate change, who reports to the board. This is typically the chief risk officer (CRO). Firms may also consider establishing specific climate or sustainability committees, in particular where there are material climate risk exposures.
Where climate risk exposures are material, or where gaps in the understanding of climate risks are present, specialist expertise is encouraged by the CBI. Board training on climate-related risks and ESG issues may be a way to address this. Companies may also consider holding climate risk workshops to identify potential exposures. Performing a climate risk deep dive as part of the annual ORSA process may offer valuable insight to the board on a firm’s climate risk exposures. For some companies, climate risk may become a standing item on the Risk Committee agenda.
More broadly, the CBI has also noted that the board is expected to promote a culture that places emphasis on climate issues. Therefore, companies should also consider ways to reduce their own carbon emissions in serving the needs of consumers and the wider economy as we transition to a low-carbon economy. With this in mind, a board-approved climate risk strategy or risk tolerance may be useful in terms of expressing the company’s position in relation to climate-related risk.
Firms need to understand the impact of climate change on risk profiles and enhance existing risk management frameworks to ensure robust climate risk identification, measurement, monitoring and mitigation. Climate risks are expected to impact a wide range of risks that firms seek to manage and are interconnected with the normal prudential risks that a (re)insurer is currently exposed to. The EIOPA opinion on the use of climate-related scenarios in the ORSA maps climate-related risks to prudential risks and could be a good starting point for firms in assessing risk exposures. Best practice is to update existing risk frameworks and policies to include climate-related exposures, rather than create a new climate risk policy.
Firms should begin by identifying their most material risk exposures and developing metrics and key risk indicators in order to monitor these risks as appropriate. They should then be incorporated into management information and risk reporting, which should enable the board to discuss, challenge and make decisions relating to the management of climate-related risks.
A firm’s control functions should then assess the effectiveness of climate risk management, including alignment with the board’s stated climate risk strategy or tolerance. Risk-mitigating actions may also need to be considered if available.
Scenario analysis is generally considered to be the most challenging aspect of climate risk management. Long-term time horizons, material uncertainty and lack of appropriate data are some of the key obstacles faced by firms in developing appropriate climate-related scenarios. However, regulators generally acknowledge these challenges and current expectations are that companies start somewhere with climate-related scenario analysis, even if it is somewhat simplistic initially.
When developing appropriate scenarios, companies should consider differing transition paths to a carbon-neutral future, as well as a path where no transition occurs (and physical risk exposures are higher as a result). Where possible, scenarios should reflect both actions taken by the insurer itself to manage climate-related risk exposures, as well as external developments such as actions taken by the wider industry, technology changes, changing government policies, regulation and consumer sentiment. Approaches to scenario analysis will need to evolve and mature over time.
There are numerous ways in which climate risk scenarios can be developed. The mappings provided by EIOPA in its opinion on climate risk scenarios in the ORSA can be used by companies to build a narrative around climate change scenarios and how these scenarios could impact the existing risk exposures of the company. For simplicity, scenarios can be incorporated into existing models, for example a firm’s ORSA model. However, existing models may need to be adapted to capture certain climate factors within the assumptions or to consider a sufficiently long enough time horizon. The CBI did not specify how long the time horizons in the scenario analysis should be. However, in the UK, the PRA expects both short-term and medium-term scenarios (over the business planning horizon) and longer-term scenarios in the order of decades. For longer-term scenarios, the PRA accepts that the analysis may be qualitative in nature, but it should still be used to inform strategy.
Business model analysis should be carried out to determine the impacts of climate risks and opportunities on the firm’s risk profile and business strategy. There is a strategic and reputational risk associated with shifting sentiment and societal preferences relating to climate change. Shifting consumer sentiment could diminish demand for existing insurance products and services if sustainability factors are not adequately considered.
Insights gained from scenario analysis should feed into the strategy-setting process and should support the future viability of the firm’s business model during the transition to a low-carbon economy. Business model changes could include the development of new products and fund offerings to consumers and investors. Results of the CBI’s emerging risk survey published in 20219 show that the vast majority of firms are not yet taking steps to develop climate-related opportunities as part of their strategies.
The CBI wants firms to adhere to transparency and disclosure principles and requirements which are focussed on consumer protection.
Firms are also expected to disclose information and data on climate-related risk exposures, the potential impact of these risks on a firm’s financial and operational resilience and how it plans to manage and mitigate such risks. These expectations are aligned with the TCFD recommendations, which could be a useful starting point when developing climate risk disclosures. However, it is notable that the CBI has not introduced mandatory disclosures at this stage. In the UK, the PRA has requested that larger insurers, with assets under management (AUM) greater than £25 billion, begin to comply with the TCFD recommendations in 2022 and publish climate-related disclosures in 2023 in line with SS3/19. Insurers with AUM between £5 billion and £25 billion have an extra year to comply.
The CBI has also specifically stated that companies must not engage in greenwashing. For the moment there is no standard accepted definition of what a “green” or “sustainable” insurance product is so this may be challenging for firms. This is an issue affecting many companies across Europe.
Under the European Union’s Sustainable Finance Disclosure Regulation (SFDR)10 and the Taxonomy Regulation,11 Regulatory Technical Standards (RTS)12 relating to sustainability disclosures are being drafted by three European supervisory authorities, including EIOPA. The European Commission will apply all of the RTS in a single delegated act, which is expected later this year. This will apply to financial market participants, including insurers and financial advisers. The aim of the RTS is to provide clear disclosures to consumers regarding financial products invested in environmentally sustainable economic activities and the establishment of a single rule book for sustainability disclosures under the SFDR and the Taxonomy Regulation.
Companies should consider what evidence they have to support claims of “green” or “sustainable” products during the product development process. Such evidence may be disclosed to consumers to substantiate these claims. In the UK, companies are beginning to consider potential litigation risks associated with the use of these terms and with mandatory climate risk disclosures in general. It will be interesting to see how this develops as the first wave of mandatory TCFD disclosures begin to be published in the UK in 2022.
The International Association of Insurance Supervisors (IAIS) published its first quantitative study on the impact of climate change on insurers’ investments13 in September 2021. The report, a first such global quantitative study, assesses how insurance sector investments are exposed to climate change.
The report gathers data from 32 IAIS members covering 75% of the global insurance sector. The analysis showed that more than 35% of insurers’ investment assets could be considered climate-relevant. The analysis uses NACE codes14 to separate equities and corporate bonds into Climate Policy Relevant Sectors (CPRS)15 and the Notre Dame Global Adaptation Initiative (ND-GAIN)16 index to assess the exposure to government bonds. Within the equities, corporate bonds and property asset classes, the majority of climate-relevant exposures relate to counterparties in the housing and energy-intensive sectors. However, the report also highlights significant regional differences in terms of balance sheet asset composition and exposures to climate-relevant sectors, with Latin America, Europe and South Africa having more exposure than other regions.
The results of the scenario analysis show the potential impacts on the insurance sector of alternative policy approaches to climate change. Under an orderly transition scenario, results estimate a drop in insurers’ available capital of around 7% to 8% of their required capital. That drop increases to over 14% under a disorderly transition scenario, and to almost 50% under a “too little, too late” scenario. The scenario analysis confirms the significant benefits of an orderly transition from both a financial stability and solvency perspective.
Over 2022, we expect that the CBI will begin to engage with (re)insurers to understand their climate-related risk exposures and to understand what (re)insurers are doing to meet the CBI’s expectations in this area.
Many (re)insurers have already added climate risk management to their risk management priorities for 2022, with a focus on climate risk workshops, ORSA deep dives and board and senior management training. In the UK, many (re)insurers have used board and senior management training as a tool to increase engagement on this topic and to initiate action.
Irish companies that are part of larger European groups, or have relationships with UK companies, may already be further down the track in understanding their risk exposures. It is expected that the experience of insurers in the UK in relation to the SS3/19 requirements will be used to determine best practice for insurers in the Irish market and further afield.
Our consultants have been involved in advising our clients on climate-related risks for (re)insurers. We have undertaken a range of work, from identifying, assessing and measuring climate risk exposure to scenario analysis.
We recently published a series of papers on climate risk management for life insurers and solutions.
Milliman can also assist you with other aspects of your climate change risk management, including advice on:
For further information, please contact your usual Milliman consultant or those below.
1CBI (3 November 2021). Supervisory Expectations of Regulated Firms Regarding Climate and Other ESG Issues. Retrieved 21 January 2022 from https://www.centralbank.ie/docs/default-source/news-and-media/press-releases/governor-letter-climate-expectations-november-2021.
2Government of Ireland. Climate Action Plan 2021: Securing Our Future. Retrieved 21 January 2022 from https://assets.gov.ie/203558/f06a924b-4773-4829-ba59-b0feec978e40.pdf (PDF download).
4EIOPA (19 April 2021). Opinion: On the supervision of the use of climate change risk scenarios in ORSA. Retrieved 21 January 2022 from https://www.eiopa.europa.eu/sites/default/files/publications/opinions/opinion-on-climate-change-risk-scenarios-in-orsa.pdf.
5EIOPA (10 December 2021). Consultation paper on application guidance on running climate change materiality assessment and using climate change scenarios in the ORSA. Retrieved 21 January 2022 from https://www.eiopa.europa.eu/sites/default/files/publications/consultations/consultation-paper-on-application-guidance-on-using-climate-change-scenarios-in-the-orsa.pdf.
6TCFD.TCFD Recommendations. Retrieved 21 January 2022 from https://www.fsb-tcfd.org/recommendations/.
7PRA (April 2019). SS3/19: Enhancing banks’ and insurers’ approaches to managing the financial risks from climate change. Retrieved 21 January 2022 from https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/supervisory-statement/2019/ss319
8New York Department of Financial Services (15 November 2021). Guidance for New York Domestic Insurers on Managing the Financial Risks From Climate Change. Retrieved 21 January 2022 from https://www.dfs.ny.gov/system/files/documents/2021/11/dfs-insurance-climate-guidance-2021_1.pdf.
9CBI (May 2021). Understanding the Future of Insurance: Climate and Emerging Risk Survey. Retrieved 21 January 2022 from https://www.centralbank.ie/docs/default-source/regulation/industry-market-sectors/insurance-reinsurance/solvency-ii/communications/understanding-the-future-of-insurance.pdf.
10The full text of the regulation is available at https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32019R2088&from=en.
11The full text of the regulation is available at https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32020R0852&from=EN.
12EIOPA et al. (22 October 2021). Final Report on Draft Regulatory Technical Standards. Retrieved 21 January 2022 from https://www.esma.europa.eu/sites/default/files/library/jc_2021_50_-_final_report_on_taxonomy-related_product_disclosure_rts.pdf.
13IAIS (2021). The Impact of Climate Change on the Financial Stability of the Insurance Sector. Global Insurance Market Report. Retrieved 21 January 2022 from https://www.iaisweb.org/page/supervisory-material/financial-stability/global-insurance-market-report-gimar/file/99548/gimar-special-topic-edition-climate-change (PDF download).
15Battiston, S. et al. (27 March 2017). A climate stress-test of the financial system. Nature Climate Change. Retrieved 21 January 2022 from https://doi.org/doi:10.1038/nclimate3255.
16ND-GAIN. Helping countries and cities counter the risks of a changing climate. Retrieved 21 January 2022 from https://gain.nd.edu/.