The challenges for insurers in tackling climate change

This article was originally published on Insurance Day, April 2022.

Insurers must continue to support climate change research and forecasting, as well as commit to sharing it for the common good. Extinction Rebellion’s protests outside Lloyd’s head­quarters in April 2022 made headline news, highlighting the real demands that the insurance industry is facing to tackle climate change.

It is no secret that in recent years, insurers (much like many industries) have sought to balance their corporate social responsibility with their obligations to stakeholders.

But now, damage to the value of insurers’ investments through the increased frequency and severity of catastrophic events is being compounded by the hit to profitability of their property/casualty books of business. Quite apart from insurers’ clear corporate responsibility to do more, it is uncontroversial that their balance sheets will benefit from influencing change and fostering innovation in relation to climate change.

Collaboration between insurers, government, regulators and other key stakeholders is vital to driving environmental, social and governance (ESG) transition.

The Association of British Insurers’ climate change roadmap outlines the market’s role in supporting the delivery of the UK’s net zero strategy and driving meaningful action for change. The roadmap identifies four thematic pillars. These are:

  • Meeting net zero by 2050.
  • Unleashing investment capacity.
  • Sustainable industry operation.
  • Helping society adapt.

Most insurers are transitioning their investment and underwriting portfolios to net zero emissions. In developing investment and underwriting strategies, insurers are demonstrating a tangible commitment to societal and corporate resilience to climate change.

Holding to account

The Net Zero Insurance Alliance, which has over 20 members representing more than 11% of global premium volume, aims to hold re/insurers accountable for their alignment with the Paris Agreement by reference to science-based, five-year targets. Insurers will already be working with external providers to set shorter term decarbonisation targets that will ensure the 2050 net zero target is deliverable.

Mutuals such as Pool Re and Flood Re will form the blueprint for government collaborations to withstand the onslaught of catastrophic events, as well as providing insureds in perilous situations with access to affordable cover. Data will continue to be crucial in determining pricing, capital and reserves. Insurers must insist on proper risk management by their insured clients to avoid mutuals acting as disincentives. They must also continue to lobby government to fund mitigation measures.

Rather than abandoning insured clients that harm the environment, some insurers are working with those businesses as they decommission, or where possible, decarbonise their activities and move from 'brown to green'. Encouragingly, climate change exclusions such as that drafted by the Lloyd’s Market Association (LMA5570) are being introduced sparingly. Instead, insurers are developing insurance products to cover innovative technologies and renewable energy sources, enabling insured clients to invest in and scale up sustainable initiatives.

Funding mechanisms

Developing existing business models to respond to emerging risks will provide efficient funding and improve market resilience. For example, Howden have collaborated with the Danish Red Cross to create the first volcano catastrophe bond for disaster relief funding. Howden describes this as 'unlocking private capital for social good'.

Under this model, humanitarian aid funds are raised in advance and released immediately in the event of a named disaster. It is easy to see how similar models (which combine insurance, risk management and loss recovery) could be developed for other types of catastrophic events (such as the use of parametric insurance). Leveraging investment in this way is a 'win-win' for insurers.

The COVID-19 pandemic has enabled insurers to 'fast-forward' their approach to direct operational carbon emissions, reducing the environmental impact of offices and other assets and supporting employees to adjust to new work patterns. In the future, insurers will be expected to help employees to measure and reduce their individual footprint.

Insurers have introduced rigour to their procurement processes, interrogating the carbon footprint of their supply chains when placing and renewing contracts. There has been a clear shift in the weighting of management of climate risk in tenders. Insurers are working to future-proof the businesses in their supply chain and to ensure the market’s supply chain can demonstrate it is on its way to net zero.

Insured clients are committed to reducing their carbon footprints. Insurers can set themselves apart by providing tools to help their insured clients assess their own levels of risk. Tools like Marsh’s ESG Risk Rating self-assessment will help insured clients to measure their ESG performance and develop ESG strategies.

Insurers must continue to support climate change research and forecasting, and they must commit to sharing it for the common good, otherwise more protests from climate activists can be expected.

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