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29 April 2021 4 min read

Climate Risk and the London Market: why it's important to care

David Stewart

David Stewart
Partner | Financial Services | London

Climate change and the consequential risk it poses to global industry will be the defining issue of our generation.  Whilst Net Zero Carbon targets by 2050 may sound a long way off, there are immediate challenges, and opportunities, facing the London Insurance Market.

 

A clear strategy and roadmap, driven by a detailed understanding of underlying risk data is needed, now, to deliver collective success for the market and to drive competitive advantage for its participants.

 

1. Government and regulatory pressures are already evident; these will continue to grow and demand changes in the industry.

The UK government has set the world’s most ambitious climate change target, one that will be set into law in the summer of 2021. In parallel, The Bank of England’s Climate Biennial Exploratory Scenario (CBES) will assess the resilience of the UK’s largest banks and insurers and will set the agenda for ongoing regulatory scrutiny over the next decade.  Political and regulatory pressure, in the UK and Internationally, will drive fundamental changes to global industry; the underlying insurance risk and the demands placed on the London Market in providing specialty cover to its customers will be profoundly impacted.  Market participants must anticipate increased regulatory scrutiny and recognise the impact on their changing customer needs, product and pricing strategies and risk selection.

2. Climate risk will fundamentally change the global insurance market; it will be a lengthy and difficult transition.

Demand for specialty cover will change; effects on physical risks and hazards are clear to see in the global marine and aviation industries, property and casualty and liability markets where rate hardening dynamics and availability of coverage will be impacted.  There will be huge challenges in transitioning through these industry changes during which insured’s strategies, and insurance needs will fundamentally change.  The London market has a key role to play in helping its customers understand the changing nature of physical risk, demonstrating clear and adaptable underwriting policies, providing sustainable cover to its customers through this transition period.  As boldly set out by seven major insurers and re-insurers in establishing the Net Zero Insurance Alliance, the London Market, in a similar fashion, can play a leading role in the Specialty Insurance industry supporting its customers through their management of climate risk.

3. A detailed understanding of risk data and modelling of climate change scenarios will be a key requirement for the market and its participants.

Regulatory scrutiny will continue and intensify with sustained demand for disclosure of data to regulators; carriers will need to demonstrate a clear understanding of their own Physical, Liability and Transition risk at an enterprise level via stress testing and scenario modelling.  Existing enterprise risk models will no longer be fit for purpose in modelling climate risk; investment in models and enhancement of data will be required.  Looking externally, carriers and brokers who can establish deep knowledge of their customers’ changing physical and transition risk scenarios, will achieve a competitive advantage through adapting their underwriting, pricing and product strategies to meet these needs.  Rating and pricing models which rely heavily on historical data, will need to factor in the amplification of flooding, wildfire, hurricane and Cat events – linked to climate change – and the associated risk to properties, assets and lives insured.

4. Management of climate risk must be embedded into Corporate strategy; the impacts are organisation-wide. 

To address the risk and opportunities presented by climate change; the strategic agenda must be set, agreed and led at C-suite and board level.  As demonstrated by the PRA’s inclusion of climate risk into the Senior Manager Regime, regulators and customers expect top down alignment and clarity on the management of climate risk; this must be embedded within the Corporate strategy and not treated as an afterthought or merely as a risk and compliance matter.

5. As the London Market navigates these changes, there is an ongoing risk of reputational damage to businesses.

Climate action groups are actively campaigning across the Financial Services industry, with specific, recent examples in the banking and insurance sectors.  To mitigate reputational risks, the market, and individual participants, must have a clear and well published stance on climate strategy, as part of a broader ESG (environmental, social and governance) framework.  The Lloyd’s ESG Report 2020, sets out a framework for the market, within which participants will operate whilst developing specific and detailed commitments of their own.  Without an agreed, action-oriented and clearly communicated stance, the market as a whole, participating businesses and individuals face a real threat of long-term reputational damage.

Whilst climate risk poses a range of challenges to the London Market, it presents a real opportunity, both to demonstrate and lead a positive, societal impact and for the commercial sustainability of its participants.  To succeed, the London Market must drive collaboration (where alignment and consistency is required), whilst promoting the competitive specialism that participants bring in addressing their customers’ own climate risk agendas.