Four ways insurance can support a transition to a low-carbon resilient future

How well has insurance embraced climate change or built ESG into its long-term strategy? Swenja Surminski, Head of Adaptation Research, Grantham Research Institute on Climate Change and the Environment, London School of Economics and Political Science (LSE), reports that it’s still not very common to see climate change embedded into day-to-day decision-making. What can be done? Here are the things insurance and risk management can do to help building a more resilient future.

There are significant opportunities for insurance to influence risk levels, risk trends, and flow of capital. In particular, it brings a chance to prove its role as society’s risk manager and regain trust amongst clients – a commodity without which insurance cannot function. Time is starting to run out, however. According to investment bank Schroders’ climate change dashboard, the world is currently on track for a 3.8 degree warning, far from the ambitions set in the Paris Agreement, which commits the signatory country to keep climate change below 2 degrees warning to avoid truly catastrophic losses and damages.

This is a societal problem and insurers and reinsurers have both sticks and carrots in their toolbox that can help society to shift to a more sustainable pathway. What is needed is a new approach to leadership, placing climate resilience and decarbonisation at the heart of the insurance business model.

Some industry leaders have been active in the climate arena for decades and are now competing for excellence in climate disclosure, use of scenario analysis, while setting themselves ambitious carbon targets. But overall a ‘business as usual’ approach is still widespread and insurers struggle translating climate change into strategic action. The sector as a whole has still not embedded climate change into day-to-day decisions. Despite shift in awareness and concern, climate change is still regarded as a distant or ‘emerging’ issue, perceived as not yet material enough to be taken into account when planning for the next 12 months, or when making decisions about underwriting or investment. The Asset Owners Disclosure Project (PDF) finds that “Less than 0.5% of assets invested by the world’s 80 largest insurers are in low-carbon investments …, despite the insurance sector being highly exposed to its financial risks”.

Science has come a long way; there are new tools that help to map risks and trends and can inform the growing climate disclosure within the sector. But translating this into day-to-day decision manuals is still a challenge for the industry. While there is a general perception that risk disclosure is important, there is little understanding of how climate risks can be assessed, and therefore reported, managed and, ultimately, reduced.

Risk is the combination of hazard, exposure, and vulnerability. None of this is static, all of it is changing. Insurers should be the first to grasp this, to advise their customers and society on how to manage. If the sector and its stakeholders do not rise to the scale and urgency of the challenge, the sector’s traditional business model will be exposed to growing constraints as inequality and climate disruption narrow the market.

Working with clients to reduce risks, support the low-carbon transition and provide advice is essential, in particular in the following areas:

Support clients in the net-zero-carbon transition.

The decarbonisation efforts that are necessary to limit climate change are expected to cause a radical rebalancing of global economic activity over the coming decade. Vivid Economics and experts from the Grantham Research Institute have recently examined the effects of decarbonisation on the global economy up to 2030 and drawn out its implications for insurance markets. One example is the shipping sector, which conveys 90 per cent of world trade. A transition to a net-zero economy will have significant implications with companies serving new markets, adopting new technologies and having to comply with its own new decarbonisation regulations. Insurers should see this as an opportunity to support their clients in managing the risks and opportunities from the transition.

Align risk knowledge with investment decisions.

The industry has gained significant knowledge about climate change, but too little is being shared across the underwriting and investment divide. There is an inherent systemic risk if insures continue to invest in assets that their underwriters are unlikely to want to cover in the future. While the demand for climate risk analytics is increasing rapidly, largely in response to global initiatives such as the TCFD, the use of risk data and associated tools by investors and lenders remains very limited. Often, investment decisions proceed without any reflection of their exposure to climate risks. The industry needs to address the disconnect between risk know-how on the underwriting side and their investment decisions on the asset side.

Respond to growing risk of litigation in the context of climate change.

Climate related litigation is on the rise . It can relate to insurers facing litigation or their customers being exposed to liability claims. Both present a growing financial and reputational threat for which most insures have not developed a strategy nor has the industry properly assessed the risks across jurisdictions and lines of business or what this means for investment decisions.

Work with clients and society to reduce risks and increase climate resilience.

The physical impacts of climate change demand a rethink on how we invest, build and manage risk. Internationally, just 12% of funds for disaster management are put into risk reduction and prevention (adaptation/resilience) prior to a disaster, while 88% go into funding responses during, and after an event, including repair or reconstruction. This is not sustainable. Insurance can help with financial resilience but after an event, when insurance payments address the damage and losses, there is an urgent need to ensure that this leads to ‘building back better’ with a low-carbon and climate-resilient future in mind.