ECONOMICS

Bank of England head warns insurers, investors, markets of mounting climate risks

For several years, with an eye to future damage, the Bank of England's governor, Mark Carney, has spoken of how climate change and government action in response to accumulating greenhouse gases could punish investors, flummox the energy sector, distort financial markets and crimp the global economy.

Last night in London, through a wide-ranging speech at Lloyd's of London, the specialty insurance company, Carney suggested that U.K. insurers keep an eye on long-term climate hazards, too.

"The challenges currently posed by climate change pale in significance with what might come," Carney told the audience, according to a copy of his remarks.

"The combination of the weight of scientific evidence and the dynamics of the financial system suggest that, in the fullness of time, climate change will threaten financial resilience and longer-term prosperity," Carney added. "The right information allows skeptics and evangelists alike to back their convictions with their capital."

A market failure to adequately price the economic costs of Earth-warming gases may come with a large bill -- a fire sale of assets connected with and exposed to climate change effects, he said.

The volume of weather-related losses has more than tripled since the 1980s, from an average of $10 billion then to about $50 billion annually in the past decade, the central banker said. Citing work by Lloyd's analysts, Carney said the roughly 20 centimeters of water-level rise around Manhattan that has occurred since the 1950s increased insured losses due to Superstorm Sandy in New York alone by 30 percent. And some residents in the Caribbean have recently been unable to get insurance on their houses because of menacing storm patterns, effectively blocking off mortgage lending, collapsing housing markets and prices, and creating abandoned neighborhoods, Carney said.

"I have found that insurers are amongst the most determined advocates for tackling [climate change] sooner rather than later," said Carney, alluding to rising payout costs. "And little wonder. While others have been debating the theory, you have been dealing with the reality."

Compounding a rise in direct costs from storms like Sandy in 2012, losses are increasing due to indirect expenses, too, he said.

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"There is an upward trend in losses that arise indirectly through second-order events like the disruption of global supply chains," Carney told the audience at Lloyd's, which pioneered catastrophe coverage after an earthquake shook San Francisco in 1906. "Your motives are sharpened by commercial concern as capitalists and by moral considerations as global citizens."

Physical, liability and transition risks

The head of the Bank of England, the modern blueprint of central banking, described three types of climate change hazards that can affect financial stability: physical, liability and transition risks. The bank published a report assessing climate impacts on the U.K. insurance sector yesterday.

Physical risks include insurance liabilities and the falling value of assets after storm, wildfire or flood damage. Liability risks are the legal exposures through which those whose lives have been harmed by emissions could sue "those they hold responsible," Carney said, and transition risks relate to the shift to a world increasingly powered with renewables.

"Changes in policy, technology and physical risks could prompt a reassessment of the value of a large range of assets as costs and opportunities become apparent," he said.

Most other central banks, at least the most influential, appear not to have studied the economic concerns of climate change as actively as the Bank of England.

Through the "intensification of droughts," a greater number of "severe storms" and "longer and stronger heat waves," the level of financial exposure to insurers, and general providers in particular, will almost certainly climb, said Carney, likely the most outspoken central banker regarding the topic of climate change and economic stability.

U.K. insurance companies oversee approximately $2.9 trillion in assets. The global economy, under current conditions, will lose $4.2 trillion in assets -- about the value of the entire Japanese economy -- without a significant shift in energy use, the Bank of England's report forecasts.

'Stress testing' needed for portfolios

Paul Fisher, deputy head of the Prudential Regulation Authority, an arm of the Bank of England, said in March that the central bank, considering that climate change affects "insurers on both sides of their balance sheets," is studying a transformation in the insurance business.

"We are seeing ever more frequent 'record' weather events," Fisher said of storms, hotter summer months, floods and rising ocean waters, noting that insurers are responding to that shift.

"There is an opportunity for growth in underwriting new products," he said in a speech. "But the combination of concentrated exposures to large catastrophe losses, inadequate risk management and/or the potential for mispricing could undermine the sustainability of businesses."

Members of the Financial Stability Board, an international economic body affiliated with the Group of 20 countries, are considering recommending to the G-20 summit development of consistent and clear disclosure of the carbon intensity of financial assets. Carney said "stress testing" for climate risks could be a valuable technique to analyze how much companies could lose, in one manner or another, due to rising greenhouse gases.

In October last year, Carney said in a letter that the bank would study the "stranded assets" concept -- that governments would ban the extraction of pockets of coal, oil and natural gas worldwide to keep carbon emissions below dangerous levels.

That analysis is due out before the end of the year.

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