Singapore’s central bank, the Monetary Authority of Singapore, has issued guidelines to enhance the insurance sector’s resilience to and management of environmental risk through setting out sound risk management practices.
The “Guidelines on Environmental Risk Management (Insurers)” are applicable to insurers’ underwriting and investment activities, and other activities that expose insurers to material environmental risk.
The Guidelines apply on a group basis for locally-incorporated insurers. Insurers that are branches or subsidiaries of global groups may take guidance from their group’s environmental risk management frameworks, as long as the frameworks meet the expectations set out in the Guidelines.
MAS recognises that the scale, scope and business models of insurers can be different. MAS expects an insurer’s approach to managing and disclosing environmental risk to mature as the methodologies for assessing, monitoring and reporting such risk evolve. An insurer should implement these Guidelines in a way that is commensurate with the size and nature of its activities as well as its risk profile.
Environmental issues that are of concern include climate change, loss of biodiversity, pollution and changes in land use. These environmental challenges call for urgent collective actions to address environmental risk. Climate change stands at the forefront of these concerns.
MAS says that the financial impact of environmental risk on insurers can arise through physical and transition risk channels. Physical risk arises from the impact of weather events and long-term or widespread environmental changes. Transition risk arises from the process of adjustment to an environmentally sustainable economy, including changes in public policies, disruptive technological developments, and shifts in consumer and investor preferences.
Environmental risk can translate into financial risk to insurers, including:
a. Market risk: Insurers may be exposed to a decline in valuation and increased volatility in their investments (particularly in carbon-intensive sectors and companies that have contributed to significant environmental degradation) as a result of shifts in investor preferences.
b. Operational risk: Severe extreme weather events can disrupt business continuity by negatively impacting the insurer’s infrastructure, systems, processes and staff.
c.Insurance risk: Environmental changes can have a direct impact on general insurers as more frequent and severe natural catastrophe events can result in higher claims and underwriting losses. Life insurers are also impacted by such environmental changes through climate change effects (e.g. higher water/air temperature, increase in carbon dioxide levels) on morbidity and mortality risks. Environmental risk may also lead to higher liability risk, which includes the risk of environmental-related claims under liability policies as well as direct claims against insurers for failing to manage environmental risk.
d.Liquidity risk: Natural disasters can cause widespread damage to physical property and incur significant costs (e.g. construction and repair), when the insurance risk materialises, leading to a surge in need for funds, and exacerbating liquidity stresses in insurers. Insurers may also experience difficulties in liquidating assets impacted by weather events, or stranded in the transition towards an environmentally sustainable economy. Investors, who are increasingly environmentally-conscious, may also cut back on sources of funding for insurers that underwrite activities with a negative impact on the environment.
Reputational risk can arise from insurers providing insurance coverage for customers that carry on business activities that have a negative impact on the environment. Negative perception of such underwriting activities can adversely affect insurers’ abilities to maintain or establish business relationships.
Role of insurers
Besides implementing robust environmental risk management policies and processes, insurers can play a key role in the transition towards an environmentally sustainable economy by channelling capital through their underwriting and investment activities.
Contributing to sustainable activities would also mitigate reputational risk for insurers. Insurers can also contribute to global collective action by engaging with stakeholders such as customers, regulators, rating agencies, academia and civil society, to promote mutual understanding on environmental issues across sectors and geographies.
The Guidelines, released on 8 December on the sidelines of the Singapore FinTech Festival 2020, also outline what insurers can do to manage environmental risks in areas such as governance and strategy; risk management; underwriting; investment and disclosure.