Climate risk could leave businesses without cover and reduce D&O options, warns BoE

Insurance cover for businesses and homes could become “prohibitively expensive” or unavailable during the next 30 years because of the impact of climate risk, warned the Bank of England (BoE) this week following its climate stress-test exercise with UK insurers. The regulator also said the growing climate-related litigation risk could reduce cover for D&O liability. Speaking at an Association of British Insurers event this week, head of insurance at the BoE Stefan Claus said that direct, physical climate risk would increase the insurance sector’s annual losses from UK business by 50% during the next 30 years, driven by inland and coastal flooding, if governments fail to take action to tackle climate change in the next three decades. Exposures in the US, dominated by tropical cyclones, would increase annual losses for UK insurers by about 70%, he explained. Claus said insurers may have underestimated their loss estimates from climate change because models are not always able to adapt to the BoE’s prescribed assumptions. UK insurers’ profits could be dented by about £1.2bn under a ‘no additional climate action’ scenario, Claus said, which was tested alongside reaching net-zero emissions globally by 2050 under an early-action scenario and late-action scenario. “Losses of this size would make individual insurers, and the financial system overall, more vulnerable to other future shocks,” he said. Under the three scenarios tested in the 180-month-long BoE exercise, Claus said: “If insurers do not respond effectively, climate risks are likely to cause a persistent and material drag on their profitability.” But he added the industry could absorb the scale of losses. The BoE was critical of the current level of data and modelling used to understand the full scale of climate risk. “Models are sensitive to input parameters and there is a potential for results to be more severe,” Klaus said. He called for regulators and insurers to collaborate to “bridge gaps” in climate data. Insurers told the BoE in the stress test that they would both reprice insurance to cover the increased physical risk of climate change and buy more reinsurance to mitigate higher tail risk. But Claus said both strategies are problematic. “A future path with a more sudden change in physical conditions, or a rapid shift in the legislative environment, could bring an increased risk of mispricing and under-reserving,” he said. Few insurers had considered the impact of increased reinsurance premiums on their long-term profits and the increased risk to reinsurers, he added. “This highlights one dependency the industry should explore further,” Claus said. BoE analysis found that about 7% of UK households could be forced to go without insurance under a no-additional-action scenario, but Claus said this could be applied to other insurance lines of business. “One could equally imagine that a reduction of insurance coverage for directors, and professional advisers coverage, could reduce innovation and risk-taking in the corporate sector,” he said. He added: “Insurers’ responses indicated that future insurance cover could become prohibitively expensive for households or businesses, or in extremis not available at all – particularly if insurers feel they can no longer accurately assess the risk.” Under seven hypothetical climate-related litigation cases applied by the BoE against London market insurers’ client books, D&O policies were the most exposed to losses and were found to be the most vulnerable to greenwashing claims, breach of fiduciary duties litigation and claims for indirect financing of carbon emissions. More than 40% of London market insurers’ D&O policies were found on aggregate to be exposed to losses under the seven legal scenarios tested. Claus said this was the first time many insurers had extracted their liability for climate-related litigation against policy books, which again exposed problems with data and modelling, as well as with policy wording. “Some firms faced difficulty identifying and aggregating policy exposures according to specific contract wording and industry sector classifications,” Claus said. “We encourage all London market insurers to develop their data extraction and modelling techniques to enable regular scenario testing to examine whether coverage intent is aligned with contract wording,” he added. Claus said the largest insurers have made the most progress in some aspects of climate risk management, particularly on risk governance. However, he told insurers that “there is still much more to do” to understand their exposures to climate risks. The stress-test exercise exposed a lack of comprehensive and high-quality data, in particular information on corporate emissions across value chains, or Scope 3 emissions, and geographical corporate asset location data, said Claus. “Addressing data gaps for climate analysis is a priority if insurers are to deliver effective climate risk management, and to innovate and develop products to support the transition to a more climate-sustainable pathway,” he said. Most insurers are dependent on third-party models. But Claus said the need to model general insurance liabilities for a wide range of physical risks was found to be “beyond” the ability of today’s catastrophe models.

Climate risk could leave businesses without cover and reduce D&O options, warns BoE

Want to read this article?

Read Next

Marsh tracks slowdown in global Q1 rate hikes

Markel names head of terrorism in London

Insurers defend Nord Stream’s €400m lawsuit as act of war

Allstate posts nat cat loss of $343m for March

UAE flash flood losses manageable as insurers adapt to changing weather

Marsh tracks slowdown in global Q1 rate hikes

Markel names head of terrorism in London

Insurers defend Nord Stream’s €400m lawsuit as act of war

Allstate posts nat cat loss of $343m for March

UAE flash flood losses manageable as insurers adapt to changing weather

Want to read this article?

Read Next

Marsh tracks slowdown in global Q1 rate hikes

Markel names head of terrorism in London

Insurers defend Nord Stream’s €400m lawsuit as act of war

Allstate posts nat cat loss of $343m for March

UAE flash flood losses manageable as insurers adapt to changing weather

Related Articles