Insurers and the Changing Tide – APRA’s Final Prudential Practice Guide for CPG 229 and Climate Change

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What is CPG 229?

As stated in our previous itemARPA published its definitive guide to prudential practices GIC 229 Financial risks related to climate change (GC 229) on November 26, 2021. CPG 229 details what APRA considers good practice by an institution with respect to climate change and associated financial risk management. The guide addresses the financial impacts of climate change in key areas such as governance, risk management, scenario analysis and disclosure.

What does the CPG 229 bring to the table?

APRA outlines its expectations for prudent institution conduct in many areas of an institution’s business. APRA says a prudent institution will consider both the financial opportunities and the financial risks of climate change when developing the strategy. CPG 229 does not seek to impose strict obligations on institutions but rather to guide them towards managing the risks and opportunities arising from climate change so that they are consistent with APRA’s approach to other types of risk.

Figure 1 of CPG 229 provides an overview of APRA’s guidance on climate change financial risks.

Figure 1. Overview of APRA guidance on climate change financial risks

Ssource: Australian Prudential Regulation Authority, 2021

Financial risk is considered in three distinct categories – physical, transition and liability risks. A prudent institution will take a strategic and risk-based approach to managing the various risks and opportunities arising from climate change. Institutions should understand that financial risks related to climate change are also related to other risks that an institution will face. These include credit, market, operational, insurance, liquidity and reputational risks which can in turn aggravate and increase overall climate change risks and consequential loss and damage.

Figure 2 of CPG 229 provides an overview of the financial risks related to climate change.

Figure 2. Financial risks related to climate change

Source: Australian Prudential Regulation Authority, 2021

CPG 229 reinforces the governance requirements enshrined in CPS 510 and SPS 510. It states that prudent practice will involve a board of directors seeking to understand and regularly assess current and future financial risks arising from climate change that affect the institution. It provides guidance on how a prudent board and senior management might manage these risks and demands.

A prudent institution will consider climate change in its overall risk management framework and ensure that it can identify, measure, monitor, manage and report its exposure to climate risks in a manner relative to size, the composition of the business and the complexity of the institution’s business operations. .

Institutions should develop capabilities for climate risk scenario analysis and stress testing. Such practices will help institutions identify short-term and long-term risks. This includes maintaining proper documentation of the methods used in scenario analyzes and stress tests and an assessment of the limitations of these analyses.

An institution’s disclosures play a role in decision-making, particularly regarding stakeholder investment in an institution. APRA says a prudent institution should consider whether additional voluntary disclosures could be beneficial to improve transparency and provide confidence to the broader market in the institution’s approach to measurement and management. climate risks. Institutions should develop and evolve disclosure practices, regularly review disclosures for completeness, adequacy and clarity, and ensure they are ready to respond to changing and heightened stakeholder expectations for disclosures climate-related. According to APRA, best practice is for any disclosures to be produced in accordance with the framework established by the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures (TCFD).

What should insurers do?

Insurers should carefully review and follow the guidelines set out in GIC 229 and actively manage their operational and financial risks and climate change strategy. Neglecting the growing risks posed by climate change can also lead to increased risk of regulatory action, stakeholder litigation and reputational damage.

Insurers will already be considering the likely effect of climate-related financial risk on their business and reviewing their strategies for mitigating pre-existing risks associated with their business operations. These risks include market risk, liquidity risk, insurance risk and reputation risk.

In terms of market risk, insurers must take into account the impact of climate change on the pricing of their financial instruments. For example, an insurer should price its insurance policies according to the changing landscape of climate change to reflect the associated financial risks.

In addition, it is increasingly important for insurers to regularly review and ensure that appropriate governance is in place, at board and senior management level, with respect to the ongoing identification and management of climate risks.

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