Start saving now, i.e. the impact of Climate Change on insurance premiums
The French Prudential Supervision and Resolution Authority (ACPR) together with the French Central Bank (Banque de France) conducted a voluntary climate stress testing pilot exercise from July 2020 to April 2021. It stress-tested 9 banking and 15 insurance groups in France over the following hypothesis:
- 30-year long-term horizon covering the 2020–2050 period with a combination ;
- A sector-specific approach covering 55 sectors of activity, for each scenario and each geographical area considered;
- A combination of Static Balance Sheet from 2021–2025 and Dynamic Balance Sheet assumption from 2025–2050;
- Three economic and energy transition risk scenarios (all reaching “net zero” emission);
- One physical risk scenario, (the RCP8.5 from the IPCC, or a “Business as Usual” scenario);
- A bottom-up exercise covering banks and insurers aiming to analyze the interactions between the two sectors, in particular the impact of insurance coverage on banks’ risk parameters;
- An international dimension, designed to take account of the global nature of climate change and its differentiated impact across different regions of the world as well as of the international scope of the major French banking and insurance groups;
The results show that the exposure of the French Financial sector on climate change related impacts is moderate with an increase of the Cost of Risk for French banks between 30–40% in comparison with Covid-19 that increased it by 100%. This rise in the Cost of Risk is caused by the increase of the probability of default due to climate change on the most impacted sectors.
A more striking finding is however the impact on insurance companies. The pilot exercise was divided by property and human health damages, including both the natural disasters as well as human disasters such as mosquito-borne diseases, pandemics and air pollution. The model assumes that natural disasters are projected to double as a result of temperature increase between 1.4°C and 2.6°C, and a surge in vector-borne infections and in air pollution impacts on health leading to cardiovascular and respiratory diseases is expected between 2021 and 2050.
The resulting impact of climate change is deemed to widen the insurance protection gap as well as increase the number of claims. In other words insurance premiums will have to increase due to a rise in unpredictability and exposure to risk.
The stress test concludes that “premiums increase by between 130% and 200% over 30 years depending on the category, i.e., an increase in insurance premiums comprised between 2.8% and 3.7% per year”.
The Bank of England and the European Central Bank are planning to conduct climate stress testing exercises on the basis of the same scenarios. The Czech National Bank’s stance is however different since it assumes, it’s not the role of Central Banks to protect the climate. Nevertheless it will most probably have to subdue itself since the Basel Committee is advancing on its strategy to integrate climate related financial risks into banking prudential regulation
One thing is clear. The material impact of the climate change on the Financial institutions’ balance sheet is indisputable. Banks and Insurance companies need to step up their effort to combat climate changes. Scenario analysis can be an important and useful tool in the hands of financial institutions and their supervisors to guide such necessary effort but a joint action in converting our economies into Net-Zero Carbon economies will require participation from all of us.