The Climate Change Conundrum Part 1: Insurers’ Maneuvers

A study of insured losses over the last half century reveals that weather-related events have significantly escalated compared to non-climate perils. Between 2010 and 2019, global insured losses from wildfires increased by 500%. On the other hand, the humanitarian aid deficit grew from a little under a billion dollars two decades ago, to $4 billion a decade ago and is now estimated to exceed $20 billion. As much as $1.5 trillion of total pension fund capital would need to be deployed in (re)insurance to bridge this gap. In 2018, natural disasters decimated more than 10,000 people, leaving millions more homeless and caused economic losses to the tune of US$160 billion. The vast majority, 95% of the registered events were weather related.

Climate change has been rapidly rising up the public agenda, cascading into the insurance fora. While a major reason is that natural disaster insurance claims are rising, insurers are also recognizing that the mid- to long-term outlook on climate change carries major risks. Until recently, much of the focus was on the impact of rising global temperatures on insurance risk. Per the CRO Forum, near $12-$15 trillion in assets are at risk from coastal flooding alone. Not as much attention has been generally paid to how insurers are advancing efforts to address the climate challenge. But that is changing.

As the climate threat appears more poignantly, insurers are increasingly leaning towards action. A case in point is that carriers constitute 12 of the 26 members of the United Nations–convened Net-Zero Asset Owners Alliance, a coalition of institutional investors with $4.6 trillion under management that are committed to making their portfolios carbon neutral by 2050.

Insurers are reassessing their risk models, especially their reliance on historical patterns, given the changing severity and frequency of climate-related events. A large portion of assets in certain industries are poised to enter “stranded” status and will no longer have value or produce income, particularly in countries adhering to the Paris Agreement, lowering premiums for carriers that had underwritten those assets.

Evidence is growing that insurers that incorporate climate and other ESG parameters into decision making are likely to benefit from improved investment performance. By leading the narrative on climate and integrating climate risk into investment processes, carriers will get an edge in winning third-party investment mandates, especially from institutional investors, such as pension funds.

In underwriting portfolios, insurers are encouraging climate progress by modifying the customer mix and changing the composition of product and service offerings. To align better with companies having lower carbon footprints, insurers are increasingly using exclusion to remove clients with high greenhouse gas emissions from portfolios. During the underwriting process, approaches are to adjust premiums or terms and conditions on the basis of a client’s climate action. Swiss Re, for instance, has used both exclusion and engagement in its underwriting. The company announced that, by 2023, it would stop providing (re)insurance to the world’s 10% most carbon-intensive oil and gas producers and work with the remaining 90% of producers to support their transitions toward greener energy.

Insurance brokers are similarly tweaking their offerings to reflect challenges created by climate change. Willis Towers Watson has created “Climate Quantified” to enable customers to manage their climate risk by fully integrating weather and climate analytical information with the latest thinking from academia.

Insurers would do well to uncover correlations between the climate record of companies and underwriting risks. ESG factors such as health and safety have been part of insurance company risk parameters. Companies that are successfully reducing their emissions may pose better underwriting risks, especially when it concerns policies with longer time horizons. Insurers that understand these correlations are better placed to lead the pricing dynamics.

In Part 2, novel approaches adopted by insurtechs for climate control will be the focus.

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