Insurers can draw on their Solvency II experience to integrate climate risk and resilience (2023)

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About this series

Insurers increasingly find themselves being pushed to the front of the queue for meaningful action on climate risk and resilience. As the articles in this special Insurer Solutions climate risk series demonstrate, a strategic response is required that will need to consider the breadth of an insurance business across people, risk and capital.

After a period of dipping its toes into the regulatory waters of climate risk management, PRA CEO Sam Woods’ 1 July letter to UK insurance CEOs was a sign of it wading in with both feet.

The essence of his letter is summed up in one sentence: “Firms should have fully embedded their approaches to managing climate-related financial risks by the end of 2021.”

(Video) How Insurers are Rising to the Challenge of Climate Risk Disclosure

Recognising the novel nature and challenges presented by climate-related financial risks, we asked firms to have an implementation plan in place by October 2019 but did not set a date for full implementation. In light of observed progress in the analysis and management of climate-related financial risks across the financial sector, we are now clarifying our expectations on timing. Firms should have fully embedded their approaches to managing climate-related financial risks by the end of 2021. This means that by the end of 2021, your firm should be able to demonstrate that the expectations set out in SS3/19 have been implemented and embedded throughout your organisation as fully as possible. In doing this, you should continue to take a proportionate approach that reflects your institution’s exposure to climate-related financial risk and the complexity of its operations.

Extract from ‘Dear CEO’ letter from PRA CEO, Sam Woods, to insurers – dated 1 July 2020

For some companies, the letter will simply have reset or confirmed the timing of and priorities for action already taking place. For others, it may have landed with a proverbial thud.

Insurers have been here before

Either way, while the risks involved with climate may be different, UK insurers have faced a comparable challenge before, and in the not too distant past – Solvency II (as have banks to some extent with the Basel Framework). Perhaps the main parallel is the requirement to quantify the practically unquantifiable – in this case the future financial impacts to the sustainability of a business that individuals and businesses, as well as countries, rely on for financial protection – with all the uncertainties this involves.

(Video) Resilience Week: Climate resilience

Taking a similar top down, bottom up risk management approach on climate is, we believe, a way for insurers to get where they need to be in the PRA’s eyes and also create the level of internal proactiveness that will avoid regulatory requirements turning in to a ‘cliff edge’.

Looking at what is required, while we don’t want to second guess exactly what the PRA expects, the section of the letter dealing with observations on progress against Supervisory Statement 3/19 (SS 3/19) so far gives some pretty strong clues as to what’s on the regulatory horizon.

“We have reviewed a large number of firms’ SS3/19 implementation plans. We have found that most firms are making good progress in developing approaches to identify, assess, manage, report and disclose climate-related financial risks and have started to embed them in associated governance and control structures. Best practice continues to evolve and will do so for a number of years.”

Taking these elements in sequence, we start to see the underlying risk management parallels with Solvency II.

Identify – Shorter and longer-term climate risks will depend on the rate of global temperature change. While a 1.5°C increase above pre-industrial levels remains an ambition for many, the 2015 Paris Agreement (signed by 146 countries) is largely predicated on restricting climate change to a 2°C increase.

Using the climate change scenarios developed by the IPCC (Inter-governmental Panel on Climate Change), companies can start to identify the physical, transition and liability risks to which they may be exposed – be they operational (as in weather threats to premises, for example, or in underwriting), reputational (perhaps from insuring certain industries) or investment-related (e.g. threats to infrastructure and climate-driven equity movements) – and enter and monitor them in their risk registers as they would have done for factors arising from Solvency II requirements.

Assess – As with Solvency II, workshops and stress testing will play a key role, not only in assessing the materiality of, and applying appropriate proportionality to, the climate risks identified from scenario analysis but also in evaluating opportunities. As part of taking responsibility for, and an active part, in the transition to a low carbon economy, an essential step is to quantify how companies will be affected by, and can affect, the climate change trajectory.

In this respect though, cat models alone won’t be sufficient when attempting to project climate risks perhaps five, 10 or 20 years forward. Also new sources of data will come in to play.

(Video) Climate Risk Modelling: Understanding the Knowns and Unknowns

As a point of reference, many insurers found themselves in a similar situation with cyber risk – especially silent cyber (unintentional cyber coverage in other policies). Typically, the challenges of capturing relevant risk attributes in the entity databases required a lot of extra resource to add attributes to data models and to populate them with credible assumptions and estimates of relative exposure. And like cyber, climate risk assessment needs to consider the views of all stakeholders to gain a consistent view of risk and incorporate it into risk appetites.

Taking into account also the duration of climate risks and the diversity of physical, transition and liability risks, insurers will need to apply a wide range of analytics tools to tackle these questions of quantification.

Manage – Even before EIOPA (the European Insurance and Occupational Pensions Authority) announced its own consultation in October 2020 on the specific inclusion of climate risks in the Solvency II Own Risk Solvency Assessment (ORSA), the PRA letter’s reference to the need to embed management of climate risks echoed the Solvency II requirements. The board level training to instil understanding of risks and the strategy reviews and development that were part of most insurers’ Solvency II preparations will need to take place, recognising that the added complexities of external macro-economic, consumer, investor and ratings influences in climate risk will be constant variables to be taken into account.

Our overwhelming experience from working with insurers on Solvency II was that the tone set by senior management was a crucial factor in the success and efficiency of preparations. In relation to climate, there’s are added dimensions. One is the timeframes involved and the potential evolution of regulation as regulators around the world continue to become more joined up. Then, there’s the potential external reputational damage of being seen as behind the curve on climate. Another is the growing body of evidence of the role of good corporate citizenship in attracting and retaining talent.

Report and disclose – Through all its communication to date on climate risk, the PRA has made it apparent it wants to set a high bar on financial disclosure. This will require companies to have the systems and data to deliver the analytics and metrics that will support internal and external reporting.

(Video) Climate and Resiliency in Insurance Regulation

As for how or what to disclose though, the PRA has not stipulated. However, the movement behind making the currently voluntary Taskforce for Climate-related Financial Disclosures (TCFD) methods mandatory is growing, including in the UK from the Financial Conduct Authority and the Green Finance Institute. More than 1400 companies around the world, with a combined market value in the trillions, have already signed up. (Note: on 9 November, the UK joint regulator and government Taskforce for Climate-related Financial Disclosures (TCFD) published an interim report and accompanying roadmap signalling the intention to make TCFD-aligned disclosures mandatory across the economy by 2025, with a significant portion of mandatory requirements in place by 2023)1.

The TCFD framework covers four core areas – Governance; Strategy; Risk management; and Metrics and targets. Beyond pure disclosure though, TCFD is another opportunity to really get a handle on climate risks and their links to operational management, business performance and reputation.

A number of studies and reports have investigated the implications of TCFD for UK plc. Few, if any to date to our knowledge, have sought to understand companies’ readiness and intentions to report on TCFD.

In October 2020, Willis Towers Watson published its first summary report of an ongoing pulse survey examining these questions.

Governance and control – All insurers have already had to name a senior person within the company responsible for climate. As part of the process of more firmly embedding climate risk management, this ownership of climate risks will need to permeate throughout the organisation as part of the function of wider analysis, metrics and reporting. The PRA seems unlikely to punish those insurers that show they are taking positive steps in this direction but will want to see the evidence of progress by its end-2021 deadline. The EIOPA consultation note also stresses the governance and control aspects of climate risk.

Regulatory stepping stone

For companies that have been holding back and perhaps scanning the regulatory lie of the land on climate, this doesn’t leave a lot of time, particularly with the added complications of remote collaborative working during the COVID-19 outbreak.

While the PRA deadline and the EIOPA consultation (along with the developing climate policy landscape) may therefore help drive action in the near term, it’s also worth considering the bigger picture beyond regulation. We’re rapidly moving towards an economy that places greater emphasis on green finance and recovery and that values organisations (both emotionally and financially) that support them. Down the line, there could be the very real possibility of capital charges on insuring certain industries, while climate change will inevitably have wide-ranging impacts on how we all live and work.

As the recent PRA letter states, “climate change represents a material finance risk to regulated firms and the financial system.” The degree of assumed materiality may well depend on factors such as variable exposure and scale over time in different lines of business, but as an illustration of that statement being more than words, EIOPA’s recent intervention on the ORSA has the potential to be quite penal on companies using the Standard Formula to calculate their SCR (Solvency Capital Requirement) or on those that don’t reflect climate risks sufficiently rigorously in their internal model.

(Video) Climate Change Risk Assessment for the Insurance Industry

Insurers that take steps now to better understand the risks and plan for changes to their mid- to long-term strategies will be better placed to deal with them and avoid having to play catch up with the rapidly evolving regulatory environment as our collective knowledge of climate impacts grows. And if insurers can gain from the pain of having gone through preparing for Solvency II to do so – all the better surely.

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How does Solvency II affect insurance companies? ›

Solvency II sets out requirements applicable to insurance and reinsurance companies in the EU with the aim to ensure the adequate protection of policyholders and beneficiaries.

What are the main points of Solvency II? ›

The Three Pillars

Solvency II is not just about capital. It is a comprehensive programme of regulatory requirements for insurers, covering authorisation, corporate governance, supervisory reporting, public disclosure and risk assessment and management, as well as solvency and reserving.

What is the role of insurance in climate resilience? ›

Insurers can develop innovative insurance products that incentivize climate-related risk prevention, for instance through offering lower premiums to policyholders implementing climate-related adaptation measures.

What are the three pillars of solvency 2? ›

Solvency II is a risk-based capital regime, similar in concept to Basel II, based on three "pillars". Pillar 1 is a market consistent calculation of insurance liabilities and risk-based calculation of capital. Pillar 2 is a supervisory review process. Pillar 3 imposes reporting and transparency requirements.

What are Solvency II requirements for insurers? ›

Under Solvency II, capital requirements are determined on the basis of a 99.5% value-at-risk measure over one year, meaning that enough capital must be held to cover the market-consistent losses that may occur over the next year with a confidence level of 99.5%, resulting from changes in market values of assets held by ...

What is the importance of solvency in insurance? ›

This is where the solvency ratio plays an important role. It shows the overall performance of the company, whether they are weak or strong in terms of financial strength. A higher solvency ratio increases the potential of your claim settlement by paying the sum assured to your nominee in case you are no more.

What are the risk modules for Solvency II? ›

The Basic SCR is calculated by considering different modules of risks: market (equity, property, interest rate, credit spread, currency and concentration), counterparty default, insurance (separately for life, health and non-life business) and intangible assets.

What is Solvency II large risks? ›

'Large risks' as defined in the Solvency II Directive include: marine, aviation, transport classes and contracts with commercial policyholder of certain size (more than 250 employees, with turnover of more than €12.8m or balance sheet over €6.2m).

What changes are proposed for Solvency II? ›

The consultation response announced that the: 'risk margin', a capital buffer that insurance companies must hold, will be cut by 65% for life insurers and 30% for general insurers. eligibility of assets that life insurers can use to match their liabilities will be broadened.

How can insurers help climate change? ›

Provided that their capacity for innovation is not hampered by unsuitable regulatory conditions, insurers can develop products that incentivise their policyholders to also reduce their footprints or that facilitate the development of new technologies that will reduce emissions (eg renewable energies).

What is climate resilience examples? ›

Adaptation includes things like reenforcing the electric grid to better withstand extreme weather; investing in better housing and infrastructure in areas hard-hit by flooding or sea level rise; planting trees to reduce extreme heat in cities; and putting air conditioning in schools.

What are some examples of climate resilience strategies? ›

For example, a combination of nature-based solutions and building improvements, like planting street trees and installing green roofs, can help mitigate extreme heat. Actions like these are especially important in historically marginalized communities, where climate impacts can exacerbate existing inequalities.

What is solvency 2 solvency capital requirement? ›

The solvency capital requirement is the amount of funds that insurance and reinsurance companies are required to hold under the European Union's Solvency II directive in order to have a 99.5% confidence they could survive the most extreme expected losses over the course of a year.

What are the data requirements for solvency 2? ›

The Solvency II directive cites three key criteria for data quality which insurers must measure: accuracy, completeness and appropriateness. Legal responsibility for data quality ultimately lies with the insurer, regardless of how the data is sourced or aggregated.

Who has the ultimate responsibility of governance under solvency 2? ›

It is the responsibility of the administrative, management or supervisory body to ensure that the undertaking's organisational structure delivers a system of governance proportionate to the nature, scale and complexity of the risks it faces in its business activities.

What is the benefit of Solvency II diversification? ›

The Solvency II legislation recognises that the overall risk exposure of insurers can be reduced by the diversity of their business. This is because the adverse outcome from one set of risks can be offset by a more positive outcome from a different, uncorrelated, set.

What is Solvency II compliance function? ›

The compliance function in the light of Solvency II is an element of the internal control system, which also includes administrative and accounting procedures, the organisation of internal control, appropriate reporting arrangements at all levels of the insurance undertaking.

What is Tier 2 limit in Solvency II? ›

Tier 2 can be up to 50 per cent and tier 3 can be no more than 15 per cent of eligible own funds. If a limit for one tier is exceeded the item may still be capable of being counted in a lower tier.

What are the benefits of solvency? ›

Helps in Investing: Investors use solvency ratios to make informed investment decisions as it cuts the risk of losses by a huge margin. If a company's solvency ratio is high, it means that the company will effectively pay off its debt, which creates a positive sentiment around investors and increases the share price.

What should be the primary goal of insurance solvency regulation? ›

Insurance regulation consists mostly of state laws and other regulations regarding the solvency and markets of insurance companies. Solvency regulations seek to ensure that the solvency of insurers is maintained and to remedy the effects of an insolvency when it does occur.

What is the impact of solvency? ›

Solvency impacts a company's ability to obtain loans, financing and investment capital. This is because solvency indicates a company's current and long-term financial health and stability as determined by assets ratio to liabilities.

What are the two 2 major components of risk? ›

This definition includes two key aspects of risk: (1) some loss must be possible and (2) there must be uncertainty associated with that loss.

What are the two elements of integrated risk management? ›

Strategic and enterprise risk management (SERM) is the combination of both strategic risk management (SRM) and enterprise risk management (ERM).

What are the 2 elements required for risk assessment? ›

Under the Management of Health and Safety at Work Regulations 1999, the minimum you must do is:
  • identify what could cause injury or illness in your business (hazards)
  • decide how likely it is that someone could be harmed and how seriously (the risk)
Apr 21, 2023

What is solvency risk in insurance? ›

Solvency Ratio is a measure of capital adequacy. It is expressed as a ratio of Available Solvency Margin to Required Solvency Margin. The excess of assets6 over liabilities7 and other liabilities of policyholders' funds and shareholders' funds maintained by the insurer is referred to as Available Solvency Margin (ASM).

What is Solvency II review risk margin? ›

The technical provisions are defined as the amount required to be paid to transfer the business to another undertaking, in order to ensure that they meet the Solvency II requirement for market consistency. The risk margin is the difference between the technical provisions and the best estimate liabilities (BEL).

What is the best estimate liability in solvency 2? ›

Best estiMate liaBility The Best Estimate Liability is the unbiased estimate of the present value of expected future cash flows. In other words, the cash flows are valued using best estimate assumptions with no explicit margins incorporated.

What are four reasons policy makers should care about climate change list these? ›

7 documented reasons why YOU should care about climate change
  • Sea level Rise. A warmer climate will cause ice caps on mountains, Greenland, and Antarctica to melt, putting additional water into the oceans. ...
  • Farming and Food. ...
  • Health and Disease. ...
  • Immigration. ...
  • Drought and Forest Fires. ...
  • Hunting. ...
  • Business and Profits.
Mar 29, 2017

What is climate change risk? ›

What is climate risk? Climate risk is the potential for climate change to create adverse consequences for human or ecological systems. This includes impacts on lives, livelihoods, health and wellbeing, economic, social and cultural assets and investments, infrastructure, services provision, ecosystems and species.

Why climate change should be managed? ›

In some cases weather patterns, climates and natural environments are changing quicker than wildlife or people can adapt. So many of the world's biggest challenges, from poverty to wildlife extinction, are made more difficult by climate change. And things will get worse if we do nothing.

What is the difference between climate resilience and sustainability? ›

While sustainability looks at how current generations can meet their needs without compromising that ability for future generations, resilience considers a system's ability to prepare for threats, to absorb impacts, and to recover and adapt after disruptive events.

What are the pillars of climate resilience? ›

Climate resilience is defined in this book as consisting of five capacities or pillars : threshold capacity , coping capacity, recovery capacity, adaptive capacity, and transformative capacity.

What are the 5 steps to resilience? ›

Resilience is made up of five pillars: Self Awareness, Mindfulness, Self Care, Positive Relationships and Purpose. By strengthening these pillars, we in turn, become more resilient.

What are 3 mitigation strategies for climate change? ›

Mitigation strategies include retrofitting buildings to make them more energy efficient; adopting renewable energy sources like solar, wind, and small hydro; helping cities develop more sustainable transport such as bus rapid transit, electric vehicles, and biofuels; and promoting more sustainable uses of land and ...

What are the two main response strategies to climate change? ›

Key Points

Responding to climate change involves two possible approaches: reducing and stabilizing the levels of heat-trapping greenhouse gases in the atmosphere (“mitigation”) and adapting to the climate change already in the pipeline (“adaptation”).

What are 3 adaptation strategies for climate change? ›

Below are five solutions that can both curb climate change and help us cope with its impacts at the same time:
  • Protect Coastal Wetlands. ...
  • Promote the Benefits of Sustainable Agroforestry. ...
  • Decentralize Energy Distribution. ...
  • Secure Indigenous Peoples' Land Rights. ...
  • Improve Mass Transit.
Feb 10, 2020

What are Solvency II own funds? ›

Own Funds

Under current FCA and PRA rules the margin held is known as 'capital'. Under Solvency II, capital is called 'own funds' and divided into 'basic own funds' (e.g. on balance sheet amounts) and 'ancillary own funds' (such as letters of credit and guarantees) which require supervisory approval.

Is Solvency II a regulation? ›

Solvency II sets out regulatory requirements for insurance firms and groups, covering financial resources, governance and accountability, risk assessment and management, supervision, reporting and public disclosure.

What is Solvency II in simple terms? ›

Solvency II is the prudential regime for insurance and reinsurance undertakings in the EU. It has entered into force in January 2016. Solvency II sets out requirements applicable to insurance and reinsurance companies in the EU with the aim to ensure the adequate protection of policyholders and beneficiaries.

How is solvency assessed? ›

The solvency of a business is assessed by looking at its balance sheet and cash flow statement. The balance sheet of the company provides a summary of all the assets and liabilities held. A company is considered solvent if the realizable value of its assets is greater than its liabilities.

What is a good measure of solvency? ›

Acceptable solvency ratios vary from industry to industry, but as a general rule of thumb, a solvency ratio of less than 20% or 30% is considered financially healthy. The lower a company's solvency ratio, the greater the probability that the company will default on its debt obligations.

What are the 4 key functions Solvency II? ›

of the Solvency II Directive concerning the “system of governance” for all insurance undertakings. The four functions are the risk-management function, the compliance function, the internal audit function, and the actuarial function.

Who monitors insurer solvency? ›

The regulation of insurance company solvency is a function of the state. State regulators monitor the financial health of companies licensed to provide insurance in their state through analysis of the detailed annual financial statements that insurers are required to file and periodic onsite examinations.

Who is ultimately responsible for governance? ›

The board of directors is ultimately responsible for the organisation's effective governance.

What is a good solvency ratio for insurance companies? ›

IRDAI mandates a minimum solvency ratio of 150%. A high solvency ratio instils confidence in the ability of the Company to pay claims, meet future contingencies and business growth plans.

What does a loss ratio tell you about insurance company solvency? ›

It reveals how much an insurance company spent on paying claims and other expenses compared to the premium received. It is a metric that specifically measures the profitability of insurance companies.

How is solvency ratio calculated for insurance companies? ›

Solvency Ratio = (Net Income + Depreciation) / Liabilities

The solvency ratio formula compares a company's cash flow against the money it owes as the total sum assured. The higher the solvency ratio, the more assets there are compared to obligations.

Does Solvency II apply to USA? ›

The implications vary depending on how directly impacted a given U.S. company is by Solvency II. In the United States, the companies most interested in the development of Solvency II are U.S.-domiciled subsidiaries with parent companies located in the European Union (EU).

What are the most common solvency ratios? ›

Acceptable solvency ratios vary from industry to industry, but as a general rule of thumb, a solvency ratio of less than 20% or 30% is considered financially healthy. The lower a company's solvency ratio, the greater the probability that the company will default on its debt obligations.

Is high solvency ratio good or bad? ›

A high solvency ratio means your business is in a strong financial position. You are less dependent on external lenders because your investments are mainly covered by your business activities. The sale of your assets will be enough to pay creditors if anything goes wrong.

What is a reasonable solvency ratio? ›

A ratio of 2:1 is considered reasonable. The ratio can be skewed by a large amount of inventory, which can be hard to liquidate in the short term. Accordingly, this ratio works best on businesses that maintain low inventory levels, such as service organizations.

How do you analyze solvency ratios? ›

The solvency ratio helps us assess a company's ability to meet its long-term financial obligations. To calculate the ratio, divide a company's after-tax net income – and add back depreciation– by the sum of its liabilities (short-term and long-term).

How do insurance companies reduce loss ratio? ›

As you can see, there are two levers that can be pulled to improve (i.e. decrease) auto insurance loss ratio: Increasing the inward flow of money in the form of total premiums earned, and/or. Decrease the outward flow of money (i.e. insurance claims paid and other expenses).

What two kinds of losses must insurers calculate for their clients? ›

The insurer must calculate both the average frequency and the average severity of future losses with some accuracy. This requirement is necessary so that a proper premium can be charged that is sufficient to pay all claims and expenses and yield a profit during the policy period.

How do you calculate solvency ratio with examples? ›

  1. Depreciation = 50,000 (10% of 5,00,000)
  2. Solvency Ratio = (Net income + Depreciation) / (Short-term debt + Long term debt)
  3. Depreciation = 60,000 (10% of 6,00,000)
  4. Solvency Ratio = (Net income + Depreciation) / (Short-term debt + Long term debt)

Which ratio is considered as safe margin of solvency? ›

Current ratio is considered as safe margin of solvency.

What is the solvency margin of an insurer? ›

The solvency margin is the insurer's unimpaired surplus as a percent of outstanding loss reserve.

What are the Solvency II data quality requirements? ›

The Solvency II directive cites three key criteria for data quality which insurers must measure: accuracy, completeness and appropriateness. Legal responsibility for data quality ultimately lies with the insurer, regardless of how the data is sourced or aggregated.

What is the minimum solvency ratio Solvency II? ›

MCR is also referred to as the minimum equity requirement (minimum vereist eigen vermogen). A Solvency II ratio of 100% means that an insurer has share capital sufficient to ensure that he can continue to meet his obligations after a shock that is only expected to occur once in every 200 years.


1. Panel:Climate Risk and Reporting – Industry Conversation - C4I Day 2, 2022
(Connecticut Insurance Department)
2. DRI Webinar - The Resilience Landscape: Organizational and Operational Resilience
3. Resilience Week: Pension resilience
4. IAIS and SIF co-hosted webinar on climate-related risks in the insurance sector
5. Climate Risk a New Regulatory Risk? [Executive Branch Review]
(The Federalist Society)
6. A conversation about climate change mitigation and resilience
(Brookings Institution)
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