Climate Change is nudging insurers out of their comfort zone. As a handmaiden of the industry, insurers have been ensconced at the point of sale for too long. It is time for an urgent course correction and willingly head towards the moment of truth. What can be a bigger truth than the climate emergency - an outcome of anthropocentric activity hastened by the industrial revolution. Whether it calls for mitigation, adaptation or resilience would depend on how quickly the reality dawns upon them. The signals are writ large and a lip service, as it turns out today, would be catastrophic not only to USD 6 trillion-plus global insurance business but can cause a far bigger damage arising from the investments of its float. Here I pick signals from the Geneva Association, Institute of Public Policy Research, Swiss Re and The Guardian.
A new, highly complex and destabilised ‘domain of risk’ is emerging - which includes the risk of the collapse of key social and economic systems, at local and potentially even global levels. This new risk domain affects virtually all areas of policy and politics, and it is doubtful that societies are prepared to manage this risk. (“Institute for Public Policy Research”)
This is a welcome move. Yet, what needs to be evaluated is the effectiveness of the recently created International Sustainability Standards Board (ISSB) in beefing up the International Financial Reporting Standards (IFRS). Is it the impact of climate change on the balance sheet of insurance companies alone that concerns it, or will it also account for the adverse implications of insuring harmful businesses and investments into non-sustainable ones?
Transition to a low-carbon economy: Opportunity or threat?
"This is a major opportunity for the insurance industry that will, however, also come with certain risks on the liability, investment and the operational sides."
(“Insurers on the road to net-zero | Swiss Re”) We need to achieve net-zero emissions by 2050 to avoid a more-than-2°C rise in global temperature, leading to serious and irreversible damage to our planet. To reach this goal, emissions need to be cut by 50% by 2030. The global net-zero target is gaining more traction, with more than one hundred countries committing to a net-zero by 2050 target. Emissions have to remain net-negative after 2050.
Can the insurance industry play an active role in supporting this critical transition? Risk knowledge, transfer solutions and investments will be key to deployment of green infrastructure and low-carbon technologies. For instance, marine, air and road transport powered by new low-carbon fuels will need appropriate risk management and risk transfer to achieve economic viability and scale. (“Insurers on the road to net-zero | Swiss Re”)
Insurers can take on the risk of transition where price levels are adequate. The resulting demand for insurance will be new source of premium growth. On the asset side, aligning investments with net-zero targets can help to improve portfolio performance and avoid stranded assets. The new momentum in the transition to a low-carbon economy could also come with new risks for the insurance portfolios. Design and construction of innovative technologies has the potential to change the risk landscape of insurance coverages for architects, engineers and construction. (“Insurers on the road to net-zero | Swiss Re”)
Price for fundamental changes in business models
The underlying risks of certain lines of businesses may change significantly. Stricter emission regulations could lead to increased litigation risks where the targets are not met. (“Insurers on the road to net-zero | Swiss Re”) In addition, such regulations may impair high-emission companies and industries. Increasing cost pressure on high-emission assets can increase the likelihood of default-triggering losses in Credit & Surety (C&S) lines or stranded assets on the investment side. Moreover, cost pressure and subsequent lower maintenance may increase operating risk. This could lower risk quality for impaired assets and thus impact property insurance. (“Insurers on the road to net-zero | Swiss Re”)
Stewardship has its costs
Insurers face reputational risks not only from own emissions but also from those of their investees and insureds. (“Insurers on the road to net-zero | Swiss Re”) As the latter account for the sizeable chunk, they can and should play the influencer role.
Nature & Biodiversity
The Task Force on Climate-Related Financial Disclosures (TCFD) recommendations are now being implemented through legislation and regulation in many jurisdictions. Under the TCFD recommendations, insurers as well as agents in other industrial sectors should show how climate-change resilient their portfolios are. Implementing climate-change related considerations into actuarial models is one way to do this. (“Pricing nature in insurance | Swiss Re”) On the life side, the impacts of climate change are currently under investigation. As the World Health Organisation (WHO) and the Lancet Countdown on Climate Change and Health suggest, without action negative impacts on excess morbidity and mortality can be expected.
A Task force on Nature-related Financial Disclosures (TNFD) is about to emerge with the aim of developing recommendations, which could also change how insurers report and write business. A key risk driver for the frequency of pandemics is deforestation in biodiversity-rich tropical areas. (“Pricing nature in insurance | Swiss Re”)
As the risks related to the loss of nature become more material, the pressure for stringent measures increases. Economic growth is a big driver of nature’s decline, and a way to change course is to make the financial impacts in corporate accounts visible. For the insurance industry, this is good news. The increasing transparency on client exposures enables more informed and targetted underwriting and risk selection. (“Pricing nature in insurance | Swiss Re”)
The nascent carbon removal industry has been a failure till date. While continuing to attract big capital it has been dismissed as a greenwash. The problem on hand is excessive greenhouse gases in our atmosphere. The primary endeavour should, therefore, be to eliminate the very production of such emissions rather than offsets and capturing. It would be best in the interest of insurers to back the right horse.
Governments and corporates are being targeted by a wide range of litigants in many jurisdictions, for allegedly failing in their legal duties. The majority of cases have been brought against governments. However, there is unmistakable evidence that the number of lawsuits against corporates (particularly carbon majors) is on the rise. (“Global Growth in Climate Litigation and Legislation ...”) Insurers are bound to get enmeshed in this web.
The rise in Climate litigation risk is due to: Increased physical and transition risk; Increasing awareness of the climate crisis; Stronger climate commitments from governments, corporates and investors; Availability of funding for climate litigation; Evolving legal duties; Developments in climate change attribution science; and "The implications of COVID-19 on economic recovery and climate-related actions." (“Climate Change Litigation – Insights into the evolving ...”)
Emerging standards and risks represent a significant tectonic shift. Not aligning with them and merrily holding on to the supply side in business-as-usual mode has a serious downside. Having said that, the moment of truth can be elusive. As is beginning to be evident, gaming newly established standards and emerging parlance could lead to greenwashing. In the run up to the United Nations climate summit in Glasgow, UK, last year, many of the world’s most powerful businesses joined governments in pledging to reduce their carbon emissions to zero in the coming decades. But an analysis of publicly available corporate documents, such as annual sustainability reports, shows that 25 of those companies - which together are responsible for about 5% of global emissions - are actually committing to do far less.
Insurers can choose to be a litmus test for the sustainability and circularity of societal actions that pass through their fold. Aiding or abetting any such outcomes not only puts reputation at risk but has serious existential implications. The writing is on the wall and the signal is loud and clear: embrace the moment of truth.
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Praveen Gupta is a Chartered Insurer. He was part of the core founding team at the Allianz AG non-life joint venture and founding Managing Director & CEO of specialist insurer QBE’s India JV. He now devotes time to teaching, writing and speaking - with a particular focus on Climate-related causes. You can track much of his work on www.thediversityblog.com. Praveen believes that the insurance industry has an urgent and vital role in restoring planetary health. He is an important global voice in that space today.