N° 102 : French insurers facing climate change risks

The question is warranted for the insurance industry for two reasons:

• With investments totalling EUR 2,628 billion, French insurers have an important role in financing the energy transition. At the end of 2017, 10% of insurers’ investments were invested in sectors sensitive to transitional risk (sectors that produce or consume fossil energy, electricity, gas, etc.). The share of insurers’ investments localized in geographical areas subject to physical risk is very limited (6% if the Netherlands is considered a risk area, 1% otherwise), these investments being mainly located in the European Union and in North America.

• Climate risk lies at the heart of the activity of non-life insurers who therefore have risk management tools on the liability side that have been developed for many years to change their pricing and reinsurance coverage.

In order to precisely gauge the state of the progress made within the French insurance sector, the Autorité de contrôle prudentiel et de résolution (ACPR) conducted a study of all insurance market players in France last September. 139 insurers, representing 80% of French insurers’ investments, responded. This report details the main results.

While the definition of climate change risk appears relatively consensual across entities, the management of this risk remains to be improved. The breakdown of climate change risk into physical risk, transition risk and liability risk refers to risks already known by insurers, allowing them to capitalise on existing risk management tools and procedures. Nevertheless, the multifaceted nature of climate change requires new adaptations.

Insurance entities favour, on the asset side of their balance sheets, an assessment of climate change risk determined by the carbon footprint of the business sectors of their investments, or as a function of the environmental, social and governance (ESG) rating of these investments. On the liability side, the measures used are based on the geographical location of the undertakings and persons insured, as well as the impact of adverse scenarios on those liabilities. However, the forecasting dimension remains the most difficult to integrate into monitoring tools, particularly as regards the scenario of a portfolio deviation leading to temperatures rising by more than 2°C.

From this point of view, two singularities of the insurance sector deserve to be emphasized. Firstly, unlike banks or asset managers, climate risk affects not only the asset side but also the liabilities of insurance organizations; the risks associated with the increasing frequency and cost of extreme weather events, including the induced increase in mortality and tropical diseases, have a direct impact on the pricing of insurance policies and may eventually raise the question of the insurability of certain risks, with possible implications for public policies. Secondly, it appears that insurers’ experience in climate risk management is more advanced in the banking sector, thanks in part to the regular use of severe stress tests. Still, the horizon of these tests is generally very short (5 years on average), well below the supposed horizon of the materialization of transition risk (2030-2050). Furthermore, the ongoing changes to the climate cast doubt upon the validity of the historical data used for the calibration of risk assessment models.

As regards the resources devoted to the management of climate risk, staffs exclusively dedicated to this task remain limited, although a large number of employees can participate indirectly in this monitoring (underwriting, risk management, pricing, etc.). The main measure taken by insurers is the establishment of indicators to monitor climate risk developments. Beyond this, limiting investments in non-green sectors, raising awareness of asset managers, training employees, or using voting rights to influence the choices of undertakings of which they are shareholders constitute other sources of leverage that insurers use to contribute to the goal of reducing climate change set by the Paris Agreement. However, these measures mainly concern insurers’ assets; on the liability side, their strategy remains focused on setting up geographical policies and adjusting their pricing. Finally, the forward-looking dimension of climate risk management, with the implementation of developed climate scenarios, requires further strengthening.

The provisions of Article 173 of the LTE impose transparency requirements on insurers regarding their risk management and investment policies linked to climate change. Since 2017, most of the market has published the requested report, but the situation of entities of very small size has been mixed. In total, the mobilization of market players is heterogeneous: a small group of actors is positioned as leaders in the management of climate risk but a large number of insurers are still waiting for the standards of the profession. Thus, many reports do not necessarily provide all the information required by the legislator or suffer from approximations on key points. After two years of the Act’s application, it is still too early to make a definitive judgement on a process which is difficult to implement. Clearly identifying the insurers’ objectives and measuring the progress made from year to the next remains challenging.