Climate risk in non-life insurance: Strategic buy-in and complexity issues slow action

As the increasing frequency and severity of climate-related events prompts insurers to reassess their exposure and approaches to climate change risk, it is resulting in significant change for the non-life insurance sector. Insurers must balance regulatory compliance with climate-related risks and growth opportunities to enhance their resilience and build a competitive edge.

Our latest market update analyses the progress made to date by non-life insurers and the challenges they face in applying climate considerations across their business functions. Drawing upon insights from climate disclosures provided by non-life insurers and syndicates - representing 75% of the non-life insurance market - our analysis reveals that:

Climate ambition is driving progress in climate risk modelling

Leading insurers are integrating climate risk considerations throughout their business and beyond minimum regulatory requirements.

Insurers are developing a better understanding of climate risks

Many insurers have carried out initial quantitative climate modelling exercises (e.g. Bank of England’s 2021 Climate Biennial Exploratory Scenario), and are now using more sophisticated climate scenario techniques to further develop their understanding of the climate-related risks and opportunities.

Technical complexity and strategic considerations are inhibiting action

Most insurers have yet to take significant action based on their evaluation of climate risks and opportunities. The lack of established precedents, well-defined processes, and robust controls around climate modelling are hindering insurers from proactively addressing climate-related risks and opportunities.

In this update we assess the comparative maturity of climate considerations across non-life insurance functions, including: risk management, investments, underwriting, pricing, capital and reserving.

Regulation and ambition are driving climate considerations in core business functions

Climate change risk considerations are integrated to varying degrees across different business functions. Areas subject to regulatory requirements have progressed more quickly than those driven solely by corporate ambition. Some of these business functions are interlinked, and progress in one area can lead to progress in another.

We’ve mapped the maturity of climate risk consideration across business functions below:

High maturity
Medium maturity
Low maturity

High maturity

Risk management, investments and scenario analysis

High maturity in these functions has been driven by longer standing guidance and regulation, e.g. the Task Force for Climate Related Financial Disclosure (TCFD)1 framework, FCA/PRA expectations and, more recently, Climate Biennial Exploratory Scenarios (CBES) and Partnership for Carbon Accounting Financials (PCAF).

Medium maturity

Product development, underwriting, and catastrophe modelling

The maturity of climate risk consideration in product development and underwriting practices is incentivised by the ambition to facilitate the net zero transition. Clear recent changes in the frequency and severity of catastrophes has accelerated the maturity of catastrophe modelling.

Low maturity

Pricing, capital modelling and reserving

Maturity across these functions is potentially impacted by the nature of the reporting, which doesn’t focus on actuarial modelling techniques, and has limited or emerging guidance and regulation in these areas.

Leading insurers are embracing quantitative measures

We have outlined leading practices for integrating climate risk in different insurance functions, which all currently have varying maturity levels. Is your firm following market leading practice in these functions? Take a look below to find out.

Risk management: Climate change is explicitly considered in the insurer’s risk appetite, with established risk limits or exposure thresholds. Climate risk indicators and metrics are proactively used in risk monitoring processes.

Investment: Insurers are monitoring the risk and impact of investments through metrics such as climate value-at-risk, carbon footprint, portfolio temperature alignment metrics and climate stewardship metrics.

Scenario analysis: 45% of insurers have currently developed their scenario analysis post CBES. An insurer following market leading practice will have taken their climate scenario analysis beyond the first iteration and incorporated advanced considerations, such as bespoke climate scenarios, sensitivity testing, management intervention and realistic disaster scenarios.

Catastrophe modelling: Climate change is a material input into the catastrophe models through varied approaches, such as coupling catastrophe models with climate models and severity/frequency adjustments.

Underwriting and product development: Insurers are monitoring the risk and impact of their underwriting activity through metrics such as insurance-associated emissions and environmental, social, governance (ESG) ratings.

Pricing: Pricing teams are considering physical risk trends when developing pricing models.

Reserving: Reserving teams are building awareness around growing physical, transition, and litigation risks.

Capital modelling: Capital teams are carrying out materiality assessments to understand climate exposure to sub-risks and making adjustments to the capital model to reflect a forward-looking view of risk.

Integration of climate risk in risk management frameworks, scenario analysis and decision making

Climate risk is fully integrated into risk management frameworks and scenario analysis by all leading insurers, yet only 60% use it in decision-making, highlighting a gap between analysis, insight and action.

What are the next steps you can take to tackle climate risk in your business?

Most insurers have taken limited action based on their assessment of climate risks and opportunities. The lack of established precedent to follow or well-defined processes, along with the complex technical aspects of modelling and strategic buy-ins, are major obstacles that hinder insurers from proactively addressing climate risks and opportunities.

There are challenges around:

Balancing financial objectives with climate goals
Scarcity of data and a need for more innovative technology
Interdependencies of business functions and processes and complexity of modelling

More specifically, the following gaps are noted for different maturity areas:

Climate change is qualitatively embedded into risk management with minimal second line oversight, there is limited disclosure on investment controls and mechanisms for addressing non-compliance with sustainability criteria, and insights from scenario analysis are not effectively integrated into key business functions.

Catastrophe modelling is complex due to the challenge of separating climate impact from random weather variations and inflationary effects, while inconsistent and scarce data deter underwriters from relying on climate metrics for decision-making.

There is limited guidance or precedent to explicitly include climate change when setting rates, reserves, and capital, making it difficult to develop and defend appropriate climate change assumptions.

The four key questions below can help frame your thinking as you start to tackle climate risk within your own business.

How does your approach to climate risk and opportunities compare to that of the market?

What is the appropriate level of action to take on climate risk within each business function?

What challanges are inhibiting you from taking action on climate risk?

What additional resources do you need to take action on climate risk?

Please contact us if you would like to read the full report, which provides further insights on best practice and challenges in climate risk modelling, or have any questions on tackling climate risk in your business.