Partnership with the California Department of Insurance
Insurance companies based in California face two increasingly critical types of climate-related risk. The first stems from their exposure to fossil-fuel investments, which are liable to precipitously lose their value as the world shifts to a low-carbon economy. The second stems from the state’s growing vulnerability to the effects of climate change, with natural disasters such as forest fires on the rise.
To help the state raise awareness of and cope with these risks, 2°ii has collaborated with the California Department of Insurance since 2016 to conduct analysis and provide information on climate change-related risks to insurers’ bond and equity portfolios.
In our first collaboration, in 2016, 2°ii worked with the Department to provide support for the Climate Risk Carbon Initiative – an effort to inform the public about potential climate change-related financial risks faced by California insurance companies resulting from their exposure to fossil fuel-based investments. 2°ii’s role was to perform a forward-looking scenario analysis of insurer investments, with special concern regarding thermal coal investments. The Department posted the aggregate scenario analysis results on its website and sent individual reports to insurers with the most assets under management and with the greatest exposure to thermal coal.
In 2018, 2°ii contributed to a stress test intended to determine climate-related risk to insurance industry investments, the first of its kind in the United States. As part of this work, 2°ii conducted an analysis of the 672 insurers in California’s market with more than $100 million in annual premiums, which account for almost $4.3 trillion in investments. It was arguably the most comprehensive financial stress test analysis ever conducted for the insurance sector. Key figures from the forward-looking scenario analysis have been published on the Department’s website.
In our most recent collaboration, in January 2019, the Department publicly released the results of another analysis, prepared by 2°ii, of the climate risk exposure faced by investments held by the insurance industry. The climate risk scenario analysis was the first of its kind to include analysis of transition risks as well as physical risks (such as drought, floods, and forest fires) faced by insurers’ assets.
PACTA stress test with the Bank of England
On June 18th, 2019, the Bank of England Prudential Regulation Authority launched its biennial insurance stress test, asking the biggest regulated life and general insurers to provide information about the impact of a range of stress tests on their business. The stress test also includes an exploratory exercise related to climate change, which looks into potential impacts on firms’ liabilities and investments stemming from physical and transition risks.
The 2° Investing Initiative has been supporting the Bank of England with designing the climate-related aspects of the stress test. On July 30th, 2019, we officially launched the stress-testing tool on the Transition Monitor website. The tool uses the breakdown of exposure to different climate-relevant sectors to calculate the effects of climate stress on a given portfolio’s value. It can be used by UK insurance companies, as well as by investors outside of the UK interested in understanding their performance under the UK stress-test.
The tool further builds on our “Storm Ahead“ stress test scenario report (January 2019), which provides guidelines for integrating scenario analysis into stress tests of regulated entities.
European Insurance and Occupational Pensions Authority (EIOPA)
2°ii’s partnership with EIOPA aims to identify and quantify potential climate transition vulnerabilities in the portfolio of European insurers.
The foreseen output comprises two separate analyses:
- An analysis of the current asset holdings of European insurers to identify the extent to which their portfolio is consistent with a 2- and 1.5-degree Celsius increase in global temperatures, respectively, and in line with the Paris climate agreement. The analysis will be designed to track the extent to which insurance companies’ portfolios are ‘accumulating’ or ‘reducing’ transition risk.
- A quantitative analysis of the total exposure to ‘transition risks’ of the portfolios and potential losses in case of abrupt fall in prices on assets on investments that are climate-relevant. It will also evaluate the potential magnitude of re-valuation under a late and sudden transition (i.e. a scenario sensitivity stress test). This analysis will be supported by a narrative explaining how the potential losses would materialize.