Climate change is a priority for the majority of C-level executives, according to a study by The Geneva Association.
The insurance industry is contributing significantly to building socio-economic resilience to climate change and supporting the transition to a low-carbon economy in their role as risk management experts and investors, although a number of challenges are hindering the industry’s efforts to scale up its contribution.
The report ‘Climate Change and the Insurance Industry: Taking Action as Risk Managers and Investors’ is based on interviews with 62 C-level executives of globally active insurance and reinsurance companies. The study has revealed that addressing the climate change challenge is a priority for the majority of C-level executives.
The issue is making its way up to company boardrooms, although the emphasis differs – specifically, climate change is approached in three ways:
- as a core business issue with implications for governance, strategy, risk management, operations and asset management;
- as a sustainability issue but transitioning into core business; and
- as a sustainability and environmental issue.
See figure below.
Taking action with regard to climate change
From the interviews, we see that two-thirds of the companies that participated in the study are actually dealing with climate change in a holistic way, ie taking into consideration physical, liability and transition risks. These firms have established dedicated teams and see the need and urgency to tackle climate change by elevating the issue above the sustainability level.
The remaining 33% of insurers who participated in the study are taking action too, but are primarily focusing on the physical risks of climate change – risks which remain at the core of the insurance business model. They coordinate climate change–related activities as part of their corporate social responsibility/sustainability activities, and look for ways to reduce their carbon footprint.
Risk management and investment strategies
On the risk transfer side, the sector has been addressing climate change through its risk management and investment strategies. For example, insurers are offering specialised risk transfer solutions that build financial resilience to impacts of extreme events, such as parametric insurance, and have supported the expansion of green and clean technologies by de-risking these complex projects from design and construction to operation and maintenance.
On the investment side, the insurance industry is increasingly integrating climate change considerations into their investment strategies and processes. Our interviews revealed various approaches to investment strategies such as:
- Not investing in companies with more than 30% of their business associated with thermal coal mining or coal power generation;
- Making a conscious choice not to divest from fossil fuel–intensive energy companies because these companies are primary investors in green and clean technologies as part of their long-term strategy (divesting could choke this critical source of funding and potentially compromise the transition to a low-carbon economy); and
- Not investing in fossil fuel-intensive sectors if they are providing underwriting services to these.
A paradigm shift
As rising socio-economic costs have become associated with physical risks of climate, there is increasing evidence of a paradigm shift in governments’ approaches, from “inaction” or “post-disaster reaction” towards a more comprehensive risk management framework.
Governments are recognising the role and benefits of insurance in carrying and transferring risk. There is increasing evidence that countries with widespread insurance coverage recover faster from the financial impacts of extreme events; it is the uninsured part of losses that drives macroeconomic costs. Yet there is a large and in some places widening protection gap, indicating that the benefits of risk transfer measures are not being harnessed to their full potential.
Action is taken – but challenges remain
In summary,
- • On the liability side, insurers are offering a variety of innovative and specialised risk transfer solutions to:
- build financial resilience to impacts of extreme events;
- incentivise reduction of greenhouse gas (GHG) emissions;
- enable entrepreneurial pathways for green and clean technology from start-up to commercialisation.
The industry is providing regional risk pools and other specialised products and services to protect governments’ budgets against the financial impact of major disasters. The industry is working to improve its products and services in areas such as business interruption and other risks associated with supply chain failures linked to climate and extreme events risks.
- On the investment side, the insurance industry is increasingly integrating climate change considerations in their investment strategies and processes. Various approaches to investment strategies are being adopted. ESG is emerging as the predominant methodology.
- On the operational side, insurers are actively working towards reducing their carbon footprint.
The study has identified a number of critical challenges, outside the scope of the insurance industry, that need to be addressed by various stakeholders, to enable the industry to expand its contributions on both the adaptation and mitigation sides.
Such hurdles, for example, limit the expansion of effective risk transfer solutions due to limited access to risk information and lack of incentive to take up insurance as a result of post-disaster government aid.
Additionally, the scaling-up of green investments is inhibited by factors such as a limited capacity of relevant markets to accommodate large-scale portfolio allocations, a need for well-defined asset classifications, and fragmented climate policy and regulatory frameworks.
In general, insurers are underwriting critical infrastructure and willing to invest and expand coverage, but a number of challenges remain. For insurers to invest in critical infrastructure, they require a stable, predictable regulatory and political framework, a pipeline of projects, and an efficient market.
Some challenges identified are:
- limited consideration has been given in many countries to assessing impacts of natural hazards throughout the entire life cycle of critical infrastructure projects;
- limited incentives, especially for private operators, to increase resilience; and
- lack of access to high quality data to assess various risks associated with all phases of the project.
Recommendations
The insurance industry is neither the polluter, nor the climate policy setter, but is a critical part of the solution. The Geneva Association offers three recommendations for the way forward (See Figure 2):
- Recommendation 1: Third-party stakeholders such as governments, policymakers, standard-setting bodies and regulators across sectors should work in a more coordinated fashion to address key barriers that hinder insurers from scaling up their contribution to climate adaptation and mitigation.
- Recommendation 2: The insurance industry should continue to institutionalise climate change as a core business issue, expand its contributions towards building financial resilience to climate risks and supporting the transition to a low-carbon economy by collaborating with governments and other key stakeholders.
- Recommendation 3: Governments and the insurance industry should explore ways to support climate-resilient and decarbonised critical infrastructure, through the industry’s risk management, underwriting and investment functions. A
Dr Maryam Golnaraghi is Director of the Extreme Events and Climate Risk research programme at The Geneva Association.