Improved management for climate change-related risks proposed: what this means for insurers

There has been increased focus in recent years on climate-related risk and the challenge this poses for insurers. In South Africa, recent significant flooding events have raised the profile of climate change and its impact on the safety and soundness of individual insurance institutions, as well as the broader insurance sector.

It is off the back of this that in August 2023, South Africa's Prudential Authority (PA) - the supervisory arm of the SA Reserve Bank - released four guidance notices for comment on climate-related risk practices and disclosures for banks and insurers. This, as the PA sees the insurance industry playing a vital role in managing climate-related risks.

A guidance note is a regulatory instrument aimed at assisting insurers to comply with requirements outlined in the relevant Governance and Operational Standards for Insurers (GOI), and has legal standing. Such notes aim to cultivate greater resilience within the financial services sector by tailoring existing regulations to mitigate new and evolving threats.

Climate change has been identified as such a threat. These guidance notes come amidst global moves to improve regulations around climate risk in the financial services industry, and to integrate Environmental, Social and Governance (ESG) into conventional financial systems.

This particular guidance note is aligned with emerging international best practices, and seeks to guide insurers on integrating climate-related risks into their governance and risk management frameworks.

It proposes that climate-related risks be addressed through governance, risk management and the Own Risk Solvency Assessment (ORSA) Prudential Standard. Insurers are expected to treat climate risk as a financial risk due to their ability to impact the solvency of insurers.

Governance relates to the roles and responsibilities of the board and senior management in managing climate-related risk. It describes these risks and opportunities over the short, medium and long term, as well as their impact on business strategy and planning.

Risk management speaks to incorporating climate-related risks into the broader risk management framework. It includes identifying and assessing climate risks, and the process for managing these risks.

Ultimately, the Prudential Authority wants to create a framework of sufficient appreciation of climate change exposure for insurers. As such, the requirement is to establish and use tools, models and metrics to monitor climate-related risk exposures as well as to allocate sufficient resources to managing these risks.

Some institutions currently leverage models while others do not explicitly consider it. However, the current solvency management framework does provide capital requirements for earthquake and hail risk, as well as the impact of reinsurance utilisation.

Reinsurance Solutions Intermediary Services (RSIS) has catastrophe modelling capabilities that allow us to quantify and manage the catastrophe risk from a reinsurance perspective. We can leverage our tools to paint a picture of the risk through scenario analysis alongside the modelling for clients. We can also assist insurers with quantifying and managing climate-related risks, both from the governance and risk management perspectives.

We can further support clients with scientific tools and specific training, to help them successfully incorporate this issue into their governance and risk management frameworks.

Our statistical models can determine the frequency and severity of perils such as flood, earthquake, hail and tropical cyclones, in order to estimate the economic or financial impact of various climate shocks. Insurers are encouraged to adopt the relevant models that are pertinent to their geographical scope and nature of business.

The increased focus on climate change-related risks that has been brewing in international markets in recent years has finally begun to make its presence felt in South Africa.

With the regulator looking to configure a framework to regulate climate change-related risk, so a more concerted effort from local financial and insurance institutions is required.

While some requirements remain at the leadership level, others require greater quantitative, analytical and technical support. Either way, insurers need to understand these requirements and the impact on their businesses, and then institute the relevant proceedings.

It is critical that insurers partner with reinsurers and reinsurance brokers with the capacity to assist in this regard and ready themselves now, in order to ensure compliance with what will be the industry's standing regulation in the near future.