UK climate stress test for insurers/banks ‘toughest yet’ - Fitch

Written by Adam Cadle

23/05/2022

The UK’s latest supervisory climate stress test for insurers and banks is the world’s toughest yet, Fitch Ratings has said, with some institutions’ capital ratios under the 30-year scenarios likely to fall close to, or even below, regulatory minimums.

Fitch said that the results, due to be published by the BoE tomorrow, “should not trigger undue investor concern because they will not be used to set capital requirements”. Instead, the BoE and the participants will use the results to assess vulnerabilities to climate risks, understand the challenges to their business models, and enhance their risk management of climate-related financial risks.

“The BoE test is tougher than last year’s French climate test,” Fitch emphasised.

“It assumers higher peak carbon prices and greater global warming, and it limits credit for the management actions that firms could take to mitigate the effect of the scenarios on their business models. In practice, we would expect companies to adjust their asset and liability profiles significantly over time to reduce their exposure to transition and physical risks. Consequently, regulatory capital breaches under the BoE scenarios do not signal that breaches in reality are likely.

“Non-life insurers and reinsurers are exposed to physical risk through property and catastrophe losses, which are becoming more frequent and severe due to climate change. Life insurers are more exposed to the transition risk that affects the assets in their investment portfolios, due to their high investment leverage. The BoE test makes no allowance for how insurers could adjust premium rates, asset allocation or reinsurance programmes over the 30-year projection period. The severe design of the BoE test brings forward the full climatic effects of each scenario as an instantaneous shock, which makes it likely that some insurers will breach their solvency ratios. In practice, we expect insurers to reprice their business and to steer their investment portfolios towards lower-risk sectors to reflect changing circumstances, and we believe they would be fairly resilient to the BoE scenarios if such management actions were taken into account.”

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