Following on from its public consultation paper in 2022, the Central Bank of Ireland (CBI) has now published its finalised guidance on climate change risk for Irish (re)insurers (Guidance).
The Guidance is designed to clarify the CBI’s expectations on how (re)insurers might address climate change risk in their business and to assist (re)insurers in developing their governance and risk management frameworks to consider and address climate change risk appropriately. Research conducted by the CBI found that only 20% of (re)insurers fully integrate climate change risk in their risk management framework, with fewer than half conducting any scenario analysis or stress testing. The Guidance applies to all (re)insurers authorised by the CBI, including captives and branches of third-country insurers authorised by the CBI.
The Guidance begins by setting out a list of overarching principles that the CBI expects Irish (re)insurers to consider when assessing and managing climate change risks. These are:
- Iterative approach: while (re)insurers may use simplified or qualitative methods initially, they should adapt and improve their risk management frameworks’ scope, depth and sophistication over time.
- that climate change risks be moved from an emerging risk to a key risk in the (re)insurer’s risk assessments.
- Double materiality: that both the effect of climate change on activities of the (re)insurer and the impact of the (re)insurer’s own activities are considered.
- That the (re)insurer’s ORSA has a central role in developing an integrated approach to climate change risk.
- That the impact of climate change is assessed across a range of time horizons (noting that the CBI acknowledges that climate change will emerge over longer time periods than (re)insurers’ typical strategic and business planning horizons); and
- Regarding (re)insurers within groups, plans or actions are appropriately adapted for local entities while remaining consistent with the group’s commitments.
The CBI has also set out its expectation that (re)insurers should consider the Guidance as a holistic approach, not as discrete sections in isolation. (Re)insurers are expected to review and monitor their material and non-material exposures to climate change risks with an appropriate frequency, given the evolving nature of climate change risk. To understand the connections between the various sections of the Guidance, the CBI has developed an infographic to be read alongside the Guidance. This infographic is available here.
The Guidance is divided into six sections which we consider in turn below:
Good governance is expected to form the foundation upon which (re)insurers respond to and integrate climate change risk into their risk management framework. It is crucial to the successful management of climate change risk. Ultimately, the board of directors (Board) is responsible for setting the (re)insurer’s risk appetite and ensuring that climate change risks are effectively identified, managed, and controlled. The CBI expects that the (re)insurer’s approach to climate change risk forms part of its overall culture, and is embedded into the strategy, business model and organisational overall structure. Senior management should understand and appropriately consider climate change risks and possess the necessary competence and capacity to assess long-term climate risks. Discussions at the Board level on climate change risks should be adequately documented in minutes of the Board.Outside the Board level, responsibility for climate change risks should be allocated to senior managers, with such duties clearly documented and understood through clear working procedures and reporting lines. Adequate resources and sufficient skill/expertise should also be devoted to managing climate change risks, which may be obtained through upskilling, advanced analytics or hiring specialist staff. In addition (in line with amendments to the Solvency II Delegated Regulation introduced in 2022), the (re)insurer’s remuneration policy should be updated to include information on how the (re)insurer considers the integration of sustainability risks in their risk management system.
- Materiality Statement
The Guidance highlights that a key component of understanding the risks posed by climate change is assessing the materiality of an undertaking’s exposure to climate change risk. When performing such an assessment, (re)insurers may wish to consider published EIOPA guidance on running such materiality assessments. The CBI highlights two key aspects of the materiality assessment – the Baseline Scenario (i.e., the (re)insurer’s view of the future from a climate change perspective) and the (re)insurer’s strategy and business model.The Baseline Scenario (which may be based on publicly available scenarios – the CBI refers to several published examples) should include the likely long-term outcome, the pathway to that outcome and related actions to achieve that outcome. The CBI expects (re)insurers to consider how risk exposure could evolve over the short, medium and long term. The CBI also expects that (re)insurers consider a broad range of physical and transition risk drivers to assess the materiality of their exposure and consider potential second-order impacts of climate change.Where (re)insurers rely on future management actions and other mitigating actions to manage climate change risk, the CBI expects the feasibility of the assumptions underlying such management actions to be assessed. The materiality assessment should be documented sufficiently to justify any conclusions reached. It should be reassessed regularly with appropriate frequency, particularly if a material change to their business model occurs.
- Scenario Analysis and Own Risk and Solvency Assessment (ORSA)
The Own Risk and Solvency Assessment (ORSA) is typically the process currently used by (re)insurers to consider the financial impact of material risks through stress and scenario analysis. However, (re)insurers must be aware that climate change risks have different characteristics than risks currently modelled, due to variations in different regions/sectors, uncertainty around their emergence and dependency on other factors, such as political actions. Therefore, while the CBI considers it appropriate to include the financial impact of material exposure to climate change risks in the ORSA, (re)insurers may use other approaches instead, as long as the CBI’s desired outcomes are achieved. (Re)insurers are expected to use an appropriate level of scenario analysis in assessing exposure to climate risks, and those who identify a material exposure must undertake a quantitative assessment of its impact over the short, medium, and long term.
- Strategy and Business Model
The CBI states that increased materialisation of climate change risks may challenge existing business models, change risk profiles, and potentially threaten the solvency of (re)insurers. This uncertainty increases the importance of adopting a forward-looking strategic approach to climate change risk management. It is expected that (re)insurers take appropriate actions to fully assess the potential impact of climate change risks, particularly where public commitments have been made about climate change. Similarly, where (re)insurers are part of a group, their plans should be consistent with any commitments made by the group.The Guidance notes that non-life (re)insurers typically take a short-term approach to underwriting risk. However, it is now expected by the CBI that they consider climate risks over a longer-term period, particularly regarding prolonged, clustered, or repeated events. External events, such as market changes, public policy, and technological advancements, should also be considered when developing the strategy and business model, given their propensity to affect the level of exposure to climate risks. In integrating climate change risks into the strategy, (re)insurers should consider the impact their own activities may have in contributing to or mitigating climate change risk.
- Risk Appetite Statement (RAS)
The CBI expects the Board of the (re)insurer to understand the climate change risks to which it is exposed, establish a documented risk appetite, and identify how exposure to climate risks will be measured, managed, and monitored. (Re)insurers with material exposure to climate change should incorporate climate change risk into their RAS. Those that have yet to identify a material exposure should establish and document their risk appetite in line with their strategy for accepting or mitigating future exposure to climate change risk. The climate change risk appetite may be defined in qualitative and/or qualitative terms. However, the CBI expects quantitative measures to be used where possible.(Re)insurers are expected to establish appropriate risk exposure limits over the short, medium, and long term and define appropriate key risk indicators to support them. Where (re)insurers, or the group they are part of, have made public climate change commitments, the CBI expects these to be integrated into the (re)insurer’s RAS, including forward-looking interim targets, which track against these commitments. The approach to integrating climate change risk in the RAS should develop over time as more advanced analytics and tools become available.
- Embedding Climate Change Risk Considerations Across the Business
The CBI expects actions set out in the strategy and business model to be operationalised in the business as usual (BAU) activities of the (re)insurer. The integration into BAU activities should be proportionate to the nature, scale, and complexity of the (re)insurer. These BAU activities include:
Risk Management – (re)insurers are expected to address climate change risks, through their existing risk management frameworks, in line with their board-approved risk appetite and their risk management policies. All risk policies should reflect the stated risk appetite relating to climate change. Where a (re)insurer belongs to a group, it should adapt the group’s climate change risk policy to suit their business model and risks, avoiding an overreliance on group resources
Reserving and Capital – under Solvency II, the calculations of the best estimate for the valuation of technical provisions should consider future developments in the external environment, including environmental developments. The CBI expects (re)insurers to consider how current and potential future changes related to climate change should be reflected in the models and assumptions currently underpinning reserving and capital assessments. (Re)insurers must understand the scope and assumptions of any external models used, while identifying and planning to address limitations in the scope and assumptions used in any model
Underwriting and Pricing – climate change creates challenges for underwriting and pricing by potentially affecting the insurability of risks in the context of a (re)insurer’s risk appetite. Notwithstanding the typical non-life approach of annual pricing, the CBI expects that all (re)insurers should consider the potential effects of pricing and underwriting decisions over the short, medium, and long-term and the implications that pricing and underwriting decisions may have on the future viability of the (re)insurer. (Re)insurers are encouraged to consider:
– how they may use their experience to identify potential solutions to ensure the continued protection of policyholders; and
– how they may influence the activities of those they underwrite, where appropriate, e.g., by incentivising policyholders to mitigate insured risks
Where relevant, the CBI expects (re)insurers to consider the future pricing and availability of key outwards reinsurance contracts and to consider any systemic risk exposure when assessing the counterparty’s ongoing capacity to pay claims. Reinsurers generally take on a range of risks, and so they may have a systemic risk exposure or concentration to climate change risks
Investments – the CBI expects (re)insurers to assess the potential impact of climate change risk on market, credit, and liquidity risk related to their investments and the potential for climate change to impact the long-term investment returns from their portfolio. (Re)insurers are expected to consider mitigating actions where material accumulations of climate change risk exposure are identified.
If you would like to discuss any of the above issues, please contact a member of the Insurance Department or your usual William Fry contact.
Contributed by: Ciaran Kenny and Mike Frazer