Nick Jessop, senior director of research at Moody's Analytics, talks about how his company has provided vital climate analytical tools for the insurance asset business

How has Moody's Analytics been assisting insurers to manage their climate risks this year? We have evolved our market and credit risk modelling capabilities to support insurers with the systematic integration of climate change into their investment, risk management and underwriting decisions.

A useful starting point is to help insurers to assess the financial impact of climate risk on their business through our Climate Pathway Scenario Service. This service translates climate pathways into the economic variables insurers need to power their asset and liability projections. This service has helped firms integrate physical and transition risk into their ORSA report and respond to TCFD disclosures. We have also helped insurers to respond to the recent BoE climate stress test with named level climate-adjusted credit risk metrics and macro forecasts as well as providing screening and analysis for pending EU taxonomy requirements.

What has become clear is that insurers need to consider the impact on climate change across their whole business; and the market as a whole is dynamic. This means taking an integrated approach to climate risk assessment and we have produced a framework to help insurers do just that, together evolving climate risk data, models and software as needs emerge.

What are the key challenges for insurance investors moving to climate investment?

Moving to climate investment has the potential to be as disruptive and transformative for the insurance industry as the move to liability driven investment was at the start of the century. As climate investment moves beyond being a niche area of expertise for sustainability teams, one of the key challenges is in understanding the financial implications of climate investments. For example, risk teams want to understand the implications of increased catastrophe risk exposures across liabilities and assets, and exposures to transition risks in investments. Investment teams need to understand if climate investments will meet fiduciary responsibilities and deliver the best financial returns available.

There is little historical precedent to guide insurers when assessing climate investments, instead scenario analysis has been a focus. Understanding how to convert climate impacts into economic and financial exposures has therefore become an industry priority. Organisations like the Network for Greening the Financial System (NGFS) have responded by developing climate scenarios specifically for the financial industry but there are still significant gaps and open questions around how best to assess longer term climate investments. Furthermore, Insurers are faced with the challenge of then understanding the scientific and socio-economic uncertainty inherent within climate risk modelling which may require increasing the number of scenarios used in investment and risk management processes.

Ultimately, insurers may well find they need to rethink how they define asset classes and investment exposures.

Transition risk is a one area often mentioned by insurance investors – how can they better address this challenge?

Insurers need to first understand their current exposures to transition risks using portfolio metrics like carbon footprints, carbon intensity as well as industry exposures and transition assessments. However, converting these non-financial exposures into traditional financial sensitivities like beta, effective duration or dollar value sensitivities requires a degree of forward looking modelling and an understanding of emerging systematic financial risks like carbon pricing, policy/regulatory risk and abatement costs.

Insurers should then look to develop a stress testing framework to support the analysis of transition risks. This could include both deterministic and stochastic modelling options. Furthermore, insurers should then look to integrate this into their existing asset-liability management (ALM) or stress testing systems/process.

Finally insurers might then look to change their asset allocations or investment strategies to better align with net zero transition pathways. Given fiduciary responsibilities to policyholders and shareholders, and uncertainty around future profitability impacts in different sectors making meaningful changes will not be easy.

Insurers have also been faced with the problems of getting reliable data on climate risk. Is this something you have helped on?

Our physical risk data solutions enable insurers to determine both asset level exposure to physical risk as well as how companies are positioning themselves to manage these risks at a strategic level. Our Energy Transition assessments provide 0-100 scores on how well companies are positioned to shift their business models in support of greener models.

In 2021, we have also rolled out our EU Taxonomy Alignment Screening which offers a granular view across all of the criteria of the EU Taxonomy. This can facilitate their mandatory reporting as well as the development of innovative products aligned with the objectives of the Paris Agreement. Combined, these solutions provide the insurance industry with a powerful set of lenses for identifying, quantifying and then acting upon climate risk.