Mark Carney has called on insurers to address the “significant challenges to general insurance business models” posed by climate change and said that improvements in risk modelling must be unrelenting, as loss frequency and severity shifts.
At a gathering of leading insurers at Lloyd’s yesterday, Carney pointed to the rapid increase in weather-related catastrophes and the spike in both the physical and financial costs. He said the challenges currently posed by climate change "pale in significance compared with what might come".
“Insurers are therefore amongst those with the greatest incentives to understand and tackle climate change in the short term. Your motives are sharpened by commercial concern as capitalists and by moral considerations as global citizens,” he said. “And your response is at the cutting edge of the understanding and management of risks arising from climate change.”
Ackowledging insurers’ “genius” in recognising that the past is not prologue “and that the catastrophic norms of the future can be seen in the tail risks of today”, Carney warned that insurance is extending into new markets not covered by existing models, adding that previously unanticipated risks are coming to the fore while increasingly volatile weather trends and hydrological cycles are making the future ever-harder to predict.
“Indeed, there are some estimates that currently modelled losses could be undervalued by as much as 50% if recent weather trends were to prove representative of the new normal,” Carney said. “In addition, climate change could prompt increased morbidity and mortality from disease or pandemics.”
Such developments have the potential to shift the balance between premiums and claims significantly, and render currently lucrative business non-viable, he went on.
“Absent actions to mitigate climate change, policyholders will also feel the impact as pricing adjusts and cover is withdrawn. Insurers’ rational responses to physical risks can have very real consequences and pose acute public policy problems,” he said.
Drawing an analogy between climate risk and asbestos, Carney said claims on third-party liability insurance – in classes like public liability, directors’ and officers’ and professional indemnity - could be brought “if those who have suffered losses show that insured parties have failed to mitigate risks to the climate; failed to account for the damage they cause to the environment; or failed to comply with regulations”.
The asset side of insurers’ balance sheets is also at risk from climate change, Carney further warned, due to insurers investments in carbon industries like coal and oil. “On the other hand, financing the de-carbonisation of our economy is a major opportunity for insurers as long-term investors. It implies a sweeping reallocation of resources and a technological revolution, with investment in long-term infrastructure assets at roughly quadruple the present rate,” Carney said.
For a transcript of Mark Carney’s speech, go to http://www.bankofengland.co.uk/publications/Documents/speeches/2015/speech844.pdf