The guidance reminds us that the ORSA, which is also known as GSSA or CISSA under the BMA, is used by insurers to assess the adequacy of their capital position and to manage material risk exposures. The BMA expects insurers to consider climate change risk in the ORSA from year end 2022 onwards. Insurers should evaluate climate change risk and describe their risk management procedures and governance, proportionate to their risk profile.
The governance description should include how climate change considerations feed into strategy, identify key roles and the responsible personnel, and demonstrate how climate change risk management is implemented at each level of the organisation. Strategy should be evaluated at least annually, and a description of the review process and its frequency included in ORSA. The risk reporting and escalation regime from function units up to Board level and any group or third-party involvement in the process should also be included.
As part of the risk management description, the insurer should set out its climate change risk appetite, risk tolerances and limits and future management actions to mitigate the risk. Both risks and opportunities for the insurer should be described, and its alignment with its overall ambition with respect to climate change risk. The guidance states that the view taken on climate change should be continuously evaluated for appropriateness as the situation evolves. In practical terms, this might translate to regular dedicated climate change review points by control functions and business units, feeding regularly into the Board.
The climate change scenario analysis should include short, medium and long-term considerations. Short term scenarios that may have a more immediate impact on the insurer should be more robustly discussed. The use of longer-term scenarios may be more relevant to strategy planning, and their use may be proportionate to the risk profile and nature of the business, such as the duration of assets and liabilities. The ORSA should describe the information relied upon in the qualitative and quantitative analysis which should be sound and up to date.
The guidance suggests using a base future scenario and extreme scenarios, such as a hot house world or disorderly transition. The scenarios should cover the material physical and transition risks and should be assessed with and without management actions. There are publicly available tools and information to assist with this process which the guidance does not specify. Some of the of the better-known sources are the the Network for Greening the Financial System (“NGFS”), the 2-Degree Investment Initiative (“2DII”) and the UN’s Intergovernmental Panel on Climate Change (“IPCC”).
Scenarios combining different degrees of physical and transition impacts are preferred due to the interlinked nature of these risks. However, this requires more sophisticated modelling and the BMA acknowledges that insurers may use more simplified approaches initially and enhance the modelling as they gain experience. The quantification may take the form of
- Single factor shock scenarios to test for vulnerabilities;
- Combined scenario with multiple risk factors impacted simultaneously;
- Balance sheet and P&L projections, perhaps using simplified methods like risk drivers;
- Reverse stress testing to highlight the point at which solvency is impacted;
- Sensitivity testing on parameters to identify sensitivities to key macroeconomic or demographic assumptions made.