Regulators have stepped up their scrutiny of how insurers are responding to climate change, pushing the industry to improve its understanding of, and ability to manage, the associated financial risks, according to Moody’s Investors Service.

Moody’s says the increased regulatory focus is sparked by growing concerns over insurers’ exposure to the threat in the form of physical risk, carbon transition risk and legal risk. The industry is also likely to be affected indirectly because climate change can potentially destabilise economies and financial markets.

Apart from seeking better insights into insurers’ exposure, regulators are also taking steps to improve the way the industry discloses its potential vulnerability to climate change.

They have additionally moved to scrutinise the industry’s climate-related stress testing and scenario analysis as well as encouraged the industry to participate in sustainable finance initiatives.

“Increased disclosure of climate-related risks will help insurers measure, benchmark and manage their exposure to climate risks,” VP-Senior Credit Officer Brandan Holmes said.

“It will also encourage them to consider climate risk and sustainability more rigorously in their investing and underwriting decisions, improving their overall risk management.”

Moody’s views as “broadly credit positive” the move by some regulators to require insurers to incorporate climate scenarios into their stress testing and scenario analysis.

It says these exercises will help insurers understand the consequences of climate change for their business. It will also support insurers’ efforts to craft climate risk management capabilities, particularly in regions where political and popular awareness of climate change is less developed.

“Regulators recognise that it will take time for insurers to become sufficiently sophisticated in their assessment of climate change risk, particularly given the lack of sufficiently detailed data,” Moody’s said.

“However, they expect insurers to move away from generic descriptions of climate risk towards a more comprehensive and focused assessment of its potential impact on their business.”