Remarks by Neville Henderson Assistant Superintendent Insurance Supervision Sector Office of the Superintendent of Financial Institutions at the Canadian Institute of Actuaries annual conference - June 16, 2021

These remarks were prepared for delivery at the beginning of discussion session on regulatory perspectives on climate change risk to insurers and the financial system.

Thank you for involving me in the discussion today.

Climate risks will affect us all and it inspires confidence knowing that Actuaries are active in assessing risks to insurers and pension plans and contributing to the discussion regarding managing those risks.

It is important to recognize that OSFI addresses climate risk through the lense of our mandate. Our mandate is to protect depositors, policyholders and other creditors from significant financial loss while allowing regulated financial institutions to compete and take reasonable risks.

We interpret reasonable risks to mean the company has adequate capital to withstand a severe but plausible adverse scenario. It is important to understand that applying this mandate restricts our purview.

We at OSFI have been actively working on climate related risks since 2016 through our participation in the Sustainable Insurance Forum (SIF) and our contribution to the development of the paper on “the Impact of Climate Risk on Insurers”. Subsequently, we assisted in the development of the joint SIF/IAIS Application paper on the “the Supervision of Climate-related Risks in the Insurance Sector”. We are also active with a number of domestic and international organizations to share perspectives and findings as our understanding of climate-related risks continues to develop.

I suspect you all already know the three climate-related prudential risks that OSFI is focussing on but it may help to specifically identify them to frame the discussion here today.

In fact, we used those risk categories in OSFI’s recently issued discussion paper on climate-related risks - namely physical risk, liability risk, and transition risk - which are consistent with international terminology. The property and casualty (P&C) industry has been dealing effectively with physical risks for decades. The organizations involved in developing the papers on the issues believed the transfer and liability risks would arise in the longer term.

As public and government concern about climate-related risks is increasing exponentially, the thinking is that the movement to a lower carbon environment and the consequences on asset values are becoming imminent.

Given the potential impact and speed of the changes, our discussion paper asks for input on how federally regulated financial institutions and pension plans can prepare for, and build, resilience to manage these risks. All of this is geared to finding the best role OSFI can, and should, play to facilitate preparedness in the industry.

We received over 70 submissions, including thoughtful input from the CIA. The feedback received will help guide our domestic prudential efforts and inform our contributions to international work such as the Sustainable Insurance forum and the IAIS, as well as domestic organizations.

We continue to analyze the input and plan to publish key findings this September. While we are still early in the process, we have found a few emerging themes from the consultation including:

  • Respondents are supportive of OSFI’s focus on climate-related risks. Some firms are assessing how these risks might affect their business and investments and would appreciate information that might guide and refine their thinking.
  • Quantifying the impacts of climate-related risks continues to be a topic of interest and some firms have been stress testing the potential effects. How companies are approaching stress testing in general, the assumptions being applied and the various correlations are all areas where they would appreciate different perspectives.
  • It is important to take into consideration international developments as well as the Canadian context when considering climate-related risks, as a number of Canadian companies will be affected either directly or indirectly by policy decisions that are made internationally.

These themes are not surprising, but the content and quality of the submissions has demonstrated desire for action and for more clarity on both implementing measures to address climate change and to improve the measures and transparency regarding those actions.

The potential significance of climate-related risks can be seen at the individual policy level and at the national and global levels. Property and Casualty premiums have increased to the point where coverage gaps are created domestically and internationally. As the public self-insures these events, the ultimate cost will be a major burden to society and ultimately to the government. One study has demonstrated that providing a combination of public and private protection decreases the economic impact and shortens the recovery period after a major catastrophic event. The conclusion is that these events can be more effectively managed though combinations of public and private enterprises.

Federal governments continue to consider how to address climate risks through long-term investments in “green” infrastructure, and through what protections can be put in place in the event of climate-related catastrophes.

These are some of the direct implications but we all must also consider how quickly these measures will be put in place and how quickly the transition to a lower carbon footprint will affect the broader economy and society.

The severe but plausible risk that OSFI is currently focusing on is transition risk or the economic change created by movement to a lower carbon based economy. While there remains debate about the definitions of green vs brown assets, and disclosing the risks associated with them, OSFI is taking the approach of doing its homework within the Canadian and global context. We see this as an essential part of setting the right prudential expectations that will have a positive long-term effect on financial institutions’ resilience.

I believe that this is also where a lot of actuaries in this room are plying their skills and expertise.

In November 2021, the Bank of Canada and OSFI announced plans for a pilot project to use climate-change scenarios to better understand the risks to the financial system related to a transition to a lower-carbon economy.

The aim here is to:

  • Build our collective climate scenario analysis capability, and support the Canadian financial sector in enhancing the disclosure of climate-related risks.
  • Increase our understanding of the financial sector’s potential exposure to risks associated with a transition to a low-carbon economy.
  • Improve our understanding of financial institutions’ current governance and risk-management practices around climate-related risks and opportunities.

This work has started with a small group of institutions from both the banking and insurance sectors (RBC, TD, Manulife, Sun Life, Intact, and Co-operators). The scenarios explore Canada’s transition to a low-carbon economy through different pathways for emission reductions. They consider how changes are driven by revised policy, advancing technology, and consumer and investor preferences, particularly, their implications for the economy and the financial system.

We recognize that climate models are complex and the correlations between the elements affecting climate change are assumption dependent. We are not under any illusions regarding how difficult it will be to interpret the results into meaningful guidance. To capture a distribution of possible transition risks, three transition scenarios were selected for this Pilot.

Leveraging extreme, yet plausible, assumptions, the scenarios explore different pathways in climate policy including both immediate and delayed action towards meeting our Paris Agreement target of limiting warming to 2°C by 2100.  The time horizon is from 2020 to 2050 (at 5-year intervals).

The following are scenario highlights:

  • Business as usual (existing climate policies): The world follows along a path consistent with policies in place at the end of 2019, implying a continued rise in emissions and temperature.
  • 2°C immediate climate policy action: Collective global action to reduce emissions towards a 2oC target begins immediately in 2020.  Because action is early, the transition is relatively smooth.
  • 2°C delayed climate policy action:  Collective global action to align with a 2oC target does not begin until 2030, after a decade of following 2019 policy frameworks. To make up for the additional decade of continued rise in emissions, the transition is steep.

This approach is consistent with ongoing work in other jurisdictions. Similar pilots are being undertaken by the PRA, APRA, and the Banque de France, the latter of which included exercises on both transition risk and physical risks. These efforts help assess potential system-wide vulnerabilities and transmission channels for risks between the financial system and the real economy. All of these pilots aim to enhance a financial institution’s own scenario analysis and stress testing activities (e.g., under ORSA and ICAAP) with sectoral views on climate risk exposures.

Over the remainder of 2021, OSFI will assess the impacts, challenges, and lessons learned from the Scenario Pilot. We will also collect information on institutions’ existing climate-related governance and risk management practices. Our intention is to publish a report summarizing OSFI’s general observations and findings before the end of the year.

We plan to use the information from the discussion paper consultation, the lessons learned from the scenario pilot exercise, and insights from the international standard setters (IAIS, BCBS, FSB, etc.) to issue expectations on climate risk management for discussion with our regulated industries in early 2022.

These are all steps towards something bigger, more flexible and more reliable for a wider range of institutions. While this work is developing, the standards of professionalism of the CIA are a key part in making well-informed decisions.

I look forward the discussion and the questions today.