Mark Carney, Bank of England governor
UK insurers will be called upon next month by the Prudential Market Authority to stress test their business against a range of climate and transition risks
UK insurers will soon be called upon to stress-test how their businesses will be affected by the low carbon transition in a bid to tackle the “cognitive dissonance” that afflicts the sector’s approach to climate risks, Bank of England governor Mark Carney has said.
Next month, as part of a market-wide stress test of the insurance sector, the BofE’s Prudential Market Authority (PRA) will ask UK insurers to consider how they would be impacted by a range of different physical and transition risks scenarios, Carney confirmed yesterday in a speech in Brussels.
He said a report in September by the Taskforce on Climate-related Financial Disclosures (TCFD) – part of the international Financial Stability Board (FSB), which Carney chairs – showed that while firms were starting to consider how to enhance the strategic resilience of their business to climate change, few companies systematically conducted detailed scenario analysis.
“Indeed, the PRA has found that despite the sophistication of insurers in modelling climate risks, there are still gaps in their own risk management,” Carney said. “The PRA is increasingly focused on cognitive dissonance in some insurers whose careful management of climate risks on the liability side of their balance sheets is not always matched by similar considerations on the asset side.”
Carney added that “we expect firms to consider scenario analysis as part of their assessments of the impact of climate risks on their balance sheet and broader business strategy”.
The PRA, which regulates over 1,500 financial institutions including banks and insurers for the BofE, is increasingly concerned about climate change threats and has previously recommended companies have at least one senior executive responsible for reporting to the board on climate risk.
Carney’s comments came as part of a speech explaining how and why the BofE was attempting to put the building blocks in place for low carbon transition across the economy.
Referencing his oft-cited ‘Tragedy on the Horizon’ speech from 2015, he explained that while markets were now beginning to understand the costs of climate risks, further progress would be driven by the coherence and credibility of government policies on climate change.
The worst climate risks can ultimately be avoided if the low carbon transition begins early and follows a predictable path, he said, “but for markets to anticipate and smooth the transition to a 2-degree world, they need the right information, proper risk management, and coherent, credible public policy frameworks”.
He said that thanks to the Paris Agreement and national policies such as the UK’s Clean Growth Strategy “some of these elements are coming into place”.
“But the task is large, the window of opportunity is short, and the stakes are existential,” he added.
“A virtuous circle is becoming possible where companies disclose more information, investors make better informed decisions, and sustainable investment goes mainstream,” said Carney. “But the speed with which this market develops will be heavily influenced by the coherence and credibility of climate policies. Finance will complement – and potentially amplify – but never substitute for climate policy action.”
He concluded that corporate reporting practices had a crucial role to play in driving the transition toward more sustainable business models and infrastructure.
“The more prolific the reporting, the more robust the risk assessment and the more widespread the return optimisation, the more rapidly this transition will happen, breaking the Tragedy of the Horizon,” he said.