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Law360, London (December 16, 2020, 12:45 PM GMT ) Regulators told insurers to put recovery from the COVID-19 crisis and climate change at the top of their list of priorities in 2021 as the sector's first climate stress-test looms.
The Prudential Regulation Authority, the Bank of England's regulatory arm, wrote to insurers on Tuesday setting out its yearly priorities for the first time. The PRA has told insurance companies to focus on financial resilience, recovery from the damage wrought by the pandemic and the perils of a changing climate in the coming year.
"The insurance sector has a crucial role to play in supporting economic recovery through provision of risk pooling to individuals and to businesses, both new and existing, long term investment and providing security of retirement income," the regulator said. "While the insurance sector has been resilient so far, the economic outlook remains uncertain."
The PRA noted that insurers' exposure to credit risk will probably jump in 2021 as the worst effects of the pandemic hit. It has asked insurers to make sure they are well-prepared to fight against downgrades and defaults.
The watchdog also said it would develop a specific stress test in 2021 to establish how well-prepared insurers are for financial shocks from events such as the COVID-19 pandemic.
The central bank also warned insurers that they must have new plans in place to combat the financial risks associated with climate change by the end of 2021.
It also noted that it will conduct its first climate-related stress test in 2021. Five U.K. life insurers and six U.K. general insurers will participate in the Climate Biennial Exploratory Scenario, which will launch in June 2021, the PRA said.
"Its objective is to test the resilience of the current business models of the largest banks, insurers, and the financial system to the physical and transition risks from climate change," the regulator told insurers.
Climate change and weather disasters have hit the finance sector hard this year. Global insured property losses arising from disasters surged to $31 billion ($42 billion) in the first six months of the year because of storms and natural disasters that could be connected to climate change, insurer Swiss Re said in August.
The PRA also warned on Tuesday that insurers not participating in the stress test should also assess the impact of climate risk on their balance sheets in a range of scenarios. They should use these internal stress tests to identify major risks..
The BoE announced in November that it had set a date of June 2021 to stress-test the financial services sector to establish how well it can withstand climate change-related shocks after delaying the plan amid the COVID-19 chaos.
Andrew Bailey, BoE governor, also warned lenders and other financial institutions that they should consider boosting their capital reserves to protect them against such risks.
"This year we have seen record wildfires in Australia and California, record-breaking temperatures in the Arctic Circle," Bailey said at the time. "These are a striking reminder of the need for sustained action by government, public authorities and the private sector."
--Additional reporting by Joanne Faulkner. Editing by Ed Harris.
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