Cold comfort: the perils of the simplified cat model

The majority of Bermuda-based insurers do not use the additional capabilities of vendor catastrophe models for long-term climate-related risk-exposure projections, according to data gathered by the Bermuda Monetary Authority (BMA). Instead, they use ‘simplified’ models for calculating long-term climate risk.

The BMA’s “2021 Climate Risk Exposure Survey Report”, published in May, shows that while almost all insurers use vendor models for modelling natural catastrophe risk, the majority of insurers (77 to 82 percent) do not yet utilise additional capabilities of vendor catastrophe models for long-term climate-related risk exposure projections (Figure 1).

Owing to this, most insurers used the “fall-back solution” provided by the BMA to determine climate risk changes, which is based on Representative Concentration Pathway (RCP) 4.5 medium-term (10 to 15-year time horizon). To provide added context, the fall-back solution to determine climate risk changes based on RCP 4.5 is simplified and does not take into consideration specific geographic features by region that could be more/less affected by climate change.

(An RCP is a greenhouse gas concentration [not emissions] trajectory adopted by the United Nations Intergovernmental Panel on Climate Change.)

Risk exposure

The report is a result of analysis carried out by the BMA on climate risk exposure data from a 2021 survey of insurance groups and commercial insurers.

“The survey demonstrated that climate change continues to be a high priority for the industry, with strides made in this area to varying degrees,” the BMA said.

“A majority of companies expressed a definitive commitment to continued risk assessment and significant attention paid to a transition to low-carbon operations.”

For P&C insurers, physical risk is the most significant driver of climate risk-related exposures due to the nature of risks underwritten in Bermuda, particularly natural catastrophe exposures.

Physical risks are risks that arise from the physical impact of climate change, while transition risks are those that result from the transition to a low-carbon economy.

“The industry has, over the years, developed high modelling expertise for short-term nat cat events. Nevertheless, modelling of mid- to long-term physical climate risk is still under development,” according to the report.

It added: “It will be important for industry to develop modelling capabilities in this area, including a long-term view, and to assess the suitability of available vendor models. This is particularly important in light of the evolving impact of inflation which, in combination with increasing physical climate change risk, has the potential of materially impacting the industry, effects of which may or may not be easily absorbed by pricing increases.”

From the asset perspective, on transition risk—it is not negligible, but there is limited exposure to what are currently considered carbon-intensive assets.

“Transition risk is carefully considered in the strategic decisions of an increasing number of companies, with many expressing that environmental, social and corporate governance (ESG) criteria have found their way into the asset management processes,” the report says.

“This exercise highlighted challenges due to a lack of universally agreed and comprehensive definitions for classifying assets for climate risk purposes. Therefore, it was difficult for some insurers to classify investments into the requested categories, and it is noted as an area for further development.”

On “green” and carbon-intensive underwriting, there is limited exposure to high-carbon intensive sectors and still “small but steadily increasing” green underwriting activity.

The overall assessment is that the exercise was beneficial, the BMA said, in identifying challenges around data and methodologies, quantifying and qualifying exposures, and encouraging all companies to focus continuously on the assessment and risk management of climate change risk.

The BMA plans to publish a guidance note in 2022 specific to risk management, governance and own risk and solvency assessment expectations, and says it will work on introducing a disclosure regime for climate-related financial risks and potential enhancements of the Bermuda Solvency Capital Return filing requirements.

Independent of regulatory requirements, the BMA said it encourages the insurance sector to focus on the topic of climate change with respect to strategy setting and continuous development of expertise in the areas of risk management, risk measurement and risk mitigation, considering the “dynamic and developing nature” of climate change risk