Climate risks could drag down insurers' profits by 15%, PRA chief warns

Written by Adam Cadle

24/05/2022

Climate risks over time could lead to an average drag on annual profits for UK insurers and banks of around 10-15%, particularly if these risks are not managed effectively, PRA chief Sam Woods has warned, following the BoE’s 2021 Climate Biennial Exploratory Scenerio (CBES) published this morning.

“These are big numbers,” he emphasised, “and the limits of the exercise mean the actual impact could well be larger due to some significant exclusions”.

“But it bears repeating that based on this exercise the costs of a transition to net-zero look absorbable for banks and insurers, without a worrying direct impact on their solvency. By themselves, these are not the kinds of losses that would make me question the stability of the system, and they suggest that the financial sector has the capacity to support the economy through the transition. But any positive message needs to be taken with a major pinch of salt: both because there is a lot of uncertainty in these projections and because this drag on profitability will leave the sector more vulnerable to other, future shocks. A world with climate change is a riskier one for the financial system to navigate.

“Early action is important to lower the cost of the transition. If we are ever to reach net-zero, a number of sectors are going to have to adapt their business models on a fundamental level. As the report sets out, it will be in the collective interests of financial institutions to support counterparties that have credible plans to adapt – and ultimately reduce their exposures to those sectors of the economy that are inconsistent with a net-zero policy."

The CBES warned that UK insurers still need to do “much more” to understand and manage their exposure to climate risk, despite “making good progress in some aspects of their climate risk management”.

The BoE said: “The lack of available data on corporates’ current emissions and future transition plans is a collective issue affecting all participating firms.” The Bank added that it will give firm-specific feedback to participants, and will use findings from the CBES to help target their efforts.

“Climate risks captured in the CBES are likely to create a drag on the profitability of insurers and banks,” it added, “particularly if they are unable to manage these risks effectively.”

“But there is substantial uncertainty around the true magnitude of these risks. And climate risks outside the scope of the CBES (such as trading losses for banks and mortality risk for life insurers) could be material.”

According to the report, life insurers noted that their ability to seize some investment opportunities would be dependent upon improvements in disclosures, while some insurers expressed a concern that a surge in green investment coiuld unduly raise asset prices.

“Without further improvement in their capabilities, banks and insurers will not be able to reflect accutately climate risks in their business decisions, for example, on pricing, lending and investment. This is important for their own long-term financial resilience. But it is also important to ensure that banks and insurers can support the economy in the transition to net-zero. Absent a more developed approach to risk management, they may resprt to actions such as withdrawing lending to carbon-intensive sectors that need finance to support their transition to less carbon-intensive production. This could give rise to wider macroeconomic risks.”

The Bank said it will help the banks and insurers it regulates to use the results of the CBES to improve their climate risk management capabilities, both through individual firm supervisory dialogue, and by sharing and discussing key thematic findings with the banking and insurance industry more broadly (including through the Climate Financial Risk Forum (CFRF)).

Related Articles