CBI spells out its expectations of (re)insurers on climate change risk
In recent years the Central Bank of Ireland (CBI) has been emphasising to firms in the financial services sector the need to engage with the issue of climate change1. The recent publication by CBI of its Consultation Paper (CP - 151) on “Guidance for (Re)Insurance Undertakings on Climate Change Risk” provides welcome insight into the CBI’s expectations of insurers in relation to how they handle climate change risk.
While the draft Guidance is directed at the insurance and reinsurance sector2, the CBI has indicated that it will consider adapting the proposed Guidance for other sectors at some future point. Firms operating in the wider financial services sector can draw upon the current draft Guidelines when developing or enhancing their own approach to the assessment and management of climate change risk.
Overarching Principles of Draft Guidance
One of the overarching principles which is set out in the draft Guidance is a recognition that (re)insurers’ approach to assessing and managing climate change risks is one which is iterative and becomes more sophisticated over time.
CBI expects that climate risk should no longer be treated as an emerging risk, but now needs to be managed as a key risk.
CBI also expects that firms will consider the impact of “double materiality” – that being the impact which climate change has on the firm itself, and the impact that the firm’s activities have on the climate.
In CBI’s view, the ORSA is central to adopting an integrated approach to managing climate change risk. Firms are expected to consider the impact of climate change over the short (5 - 10 years), medium (30 years) and long-term (80 years). CBI has emphasised that where firms seek to rely upon group policies and activities regarding climate change risk, they must be adapted for the local entity.
Helpfully the CBI has stated that the draft Guidance sets out one approach that can be taken towards the assessment and management of climate change risks and leaves open the possibility that firms may choose to adopt other approaches providing that outcomes, similar to those expected by CBI, can be achieved.
CBI advises that firms regard the draft Guidance as a holistic framework with the output from each element having an impact on the next element. The key elements of the framework are helpfullycaptured in a flowchart which has been published in conjunction with the draft Guidance.
CBI Expectations Regarding Governance
The draft Guidance reiterates that the board is ultimately responsible for setting the risk appetite and ensuring that risks are identified, managed and controlled. It follows that it is the responsibility of the board to ensure that the management of climate change risks are integrated into the risk management processes of firms.
Not surprisingly, the CBI makes it clear that it expects that decisions, discussions and actions of boards and committees are to be documented. The CBI even goes so far as to suggest that ‘where appropriate’ climate change risk becomes a standing agenda item at board/sub-committee meetings.
The CBI expects that responsibility for risks related to climate change are allocated to senior managers and that the duties and responsibilities flowing from this are documented and understood. The anticipated implementation of SEAR and the Individual Accountability Framework will, in-time, enhance requirements of this nature.
All key functions, but in particular the Risk Management function and Actuarial function are expected to contribute to the board’s decision making in respect of climate change risks.
Noting that remuneration can be used as an incentive for the better integration of climate change risks, the CBI expects that climate change related performance and risk management factors are built into a (re)insurer’s remuneration framework.
Five Key Focus Areas of CBI Guidance
Within the draft Guidance there are five key focus areas concerning the assessment and management of climate change risks, those being:
- Materiality assessment
- Scenario analysis and the ORSA
- Strategy and business model
- Risk appetite statement
- Embedding climate change risk considerations across the business
1. Materiality assessment
In order for firms to understand the extent of their exposure to climate change they are required to perform (and document) a materiality assessment. Firms are expected to establish a baseline climate change scenario and then consider the firm’s current strategy and business model so as to fully understand the potential for exposure to climate change risk. Firms are expected to conduct materiality assessments on a regular basis.
2. Scenario analysis and the ORSA
The CBI considers that the ORSA is an appropriate process in which to include the consideration of climate change risk. However, firms are free to use other approaches provided that the same outcome is achieved. The CBI expects that firms use an appropriate level of scenario analysis to assess the impact of climate change risk and to understand their exposure to that risk.
3. Strategy and business model
The CBI expects firms to fully assess the potential impacts of climate change risks on their business models and to integrate climate change risk in its overall strategy. The CBI notes that while non-life (re)insurers typically take a short-term approach to underwriting risk, the CBI expects firms to consider climate change risks over the longer term, particularly with regard to prolonged, clustered, or repeated events, and reflect these in the overall strategy and business model.
4. Risk appetite statement
Boards are expected to understand the climate change risks to which the firm is exposed, and firms which have a material exposure to climate change are expected to incorporate climate change risk into their Risk Appetite Statement. The CBI expects firms to establish appropriate risk exposure limits and thresholds relating to climate change risks over the short, medium and long term and to define appropriate Key Risk Indicators to support them.
5. Embedding climate change risk considerations across the business
The CBI expects that actions relating to climate change risk which are set out in the strategy and business model become part of the business-as-usual activities of the firm, including in particular in the areas of risk management, underwriting and pricing, reserving and capital, and investment decisions. The draft Guidance expands upon CBI’s expectations as regards the role of those functions in the assessment and management of climate change risks.
Next steps
The CBI invites feedback on the draft Guidance until 26 October 2022. It is expected that the draft Guidance will be published in final form in the months that follow.
If (re)insurers are to be in the optimum position to fulfil the requirements of Solvency II in the area of climate change risk, consistency in understanding what is required of the sector is really critical. That is why the proposed CBI Guidelines are to be particularly welcomed. We hope that the CBI will be ensuring that the finalised version of the Guidelines will be wholly consistent with the EIOPA guidelines on conducting climate change materiality assessments which were published the day before the CBI’s draft Guidelines3. The clearer and more consistent the guidance is for the industry, the lesser the compliance burden, and the faster changes can be made to help reduce the effects of climate change and the associated risks.
Looking ahead to the implementation of the draft Guidelines, it is clear that Boards will need to be seen to be actively engaged with the assessment and management of climate change risk. The proposed Guidelines therefore place a spotlight on the competence and capacity of boards to understand and assess the long-term risks and opportunities related to climate change.
Key functions within (re)insurers – such as risk management, underwriting and pricing, reserving, and investments – will have a central role to play in ensuring that the assessment and management of climate change risk becomes integral to how the business operates.
While the CBI state that the proposed Guidelines do not introduce new requirements on (re)insurers in relation to climate change risks, integral to the proposed Guidelines are processes, assessments and obligations which may mark a considerable advance on a firm’s current approach. The reality is that fulfilling the expectations of the CBI as set out in the draft Guidance are likely to require firms to commit to additional measures and resources.
Helpfully, the CBI has indicated that in supervising firms’ compliance with the proposed Guidelines it will take a proportionate and iterative approach. It explicitly recognises that in the initial period of implementation some (re)insurers may use simplified and/or qualitative approaches.
Engaging with the Consultation Process
The Consultation Paper creates an opportunity for (re)insurers to put forward their views on any aspect of the proposed Guidance on which further clarity is required. Please get in contact with us if you would like any assistance submitting on the consultation.
1 See for example, the 2019 address by Sharon Donnery entitled “Risks and opportunities from climate change” (16 May 2019). In November 2021, the CBI issued a letter to Chairs and CEOs of firms in the financial services sector in which was an attempt to set out the CBI’s supervisory expectations of firms in the context of climate change.
2 Including captive (re)insurers and also branches of third country insures which are authorised by CBI.
3 “Application guidance on running climate change materiality assessment and using climate change scenarios in the ORSA” (2 August 2022).
