N°24-38: Who Monitors Climate Risk of Financial institutions? Evidence from Catastrophe Risks in Insurance

We assess the ability of the regulators and private monitors like credit rating agencies to evaluate and discipline the exposure of the insurance industry to natural catastrophe (NatCat) risks intensified because of climate change. We demonstrate that the rating agency A.M. Best is a more stringent monitor than the US insurance regulators in that it provides more adequate assessment of insurers' exposure to NatCat risk compared to regulatory risk-based capital standards; also, it has a long-lasting discipline effect by incentivizing insurers to improve their NatCat risk management. But A.M. Best's monitoring disciplines only a limited segment of the insurance market. We show that in response to stricter rating requirements for NatCat risks, many insurers accept the downgrades and become riskier. Meanwhile, the regulatory capital requirements are not capable of curtailing their excessive risktaking.