Bank of England sees notable climate risk gaps amongst UK insurers

Projections of climate losses amongst UK insurers are uncertain, according to the results of the Climate Biennial Exploratory Scenario (CBES).

The CBES explores the financial risks posed by climate change for the largest banks and insurers operating in the UK.

The exercise was undertaken by the Bank of England (BoE), which said that scenario analysis in this area is still in its infancy and there are several notable data gaps, adding that “UK banks and insurers have made progress but still need to do much more to understand and manage their exposure to climate risks”.

The BoE asked banks and insurers participating in the CBES to use three scenarios to look at how climate-related risks could affect them. Two scenarios featured policies to limit global temperature rises (Early Action scenario and Late Action scenario), the third featured unchecked global warming (No Additional Action scenario). 

Each scenario examines the risks that could develop over a period of 30 years. The participating firms then modelled how their businesses could be affected in each scenario.

The three key objectives of the exercise were to:

  • Improve banks’ and insurers’ climate risk management – banks and insurers were asked to model risks at a granular level, including by engaging with their largest counterparties to understand better their climate exposures.
  • Size the risks that participants in the exercise face – projections were based on their current balance sheets: for banks, the exercise focused on their credit books, whilst for insurers the exercise assessed risks to both their assets and liabilities;
  • Better understand the potential responses of banks and insurers to climate-related risks and their broader implications – we ran a second round of the exercise in part to gauge participants’ reactions to their initial responses.

At an aggregate level, the BoE said UK banks and insurers are likely to be able to absorb the costs of transition that fall on them:

“The overall costs will be lowest with early and well-managed action to reduce greenhouse gas emissions and so limit climate change. Some costs that initially fall on banks and insurers will ultimately be passed on to their customers.”

It added that governments set public climate policy, which will be a key determinant of the speed and shape of changes in the global economy, pointing out that both banks and insurers have a collective interest in managing climate related financial risks in a way that supports that transition over time.

Sam Woods, deputy governor for Prudential Regulation and CEO of regulator the Prudential Regulation Authority, commented: “Recent events such as the war in Ukraine and rises in energy prices illustrate the challenges banks and insurers can face from changes in their operating environment. Today’s exercise explores how well they are equipped to manage the longer-term challenges from climate change, in the context of our financial stability objective.”

“We find that they are likely to be able to absorb the climate costs which fall on them without material risks to solvency, but will face significant headwinds and therefore need to continue to invest in their ability to support the economy’s transition to net zero.”

The BoE asked banks and insurers participating in the CBES to use three scenarios to look at how climate-related risks could affect them. Two scenarios featured policies to limit global temperature rises (Early Action scenario and Late Action scenario), the third featured unchecked global warming (No Additional Action scenario).

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